Consider the world with two countries: Country A and Country B. There are two states of...
Consider the world with two countries: Country A and Country B.
There are two
states of the world: State 1 and State 2, and the probability of
realization of each
state is 50%. In State 1, output of Country A is $100 billion, and
output of Country
B is $80 billion. In State 2, output of Country A is $90 billion,
and output of
Country B is $120 billion. Assume that the share of labor income in
output is 60%
for both countries.
(a) Derive the income distribution in each country in each state
when
there is no foreign direct investment.
(b) Consider foreign direct investment such that residents in
each coun-
try hold 50% of domestic capital stock and 50% of foreign capital
stock. Derive
the income distribution in each country in each state in this
case.
(c) Derive deviation from mean of capital income, labor income
and
total income for both countries.
(d) Based on your answers in parts (a)-(c), does foreign direct
invest-
ment help residents in the two countries diversify income risk?
Explain your
reasoning.
Homework Answers
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Consider the world with two countries: Country A and Country B.
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