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PSU ECON 304 - ECON 304 HW 6 (2)

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Name Date last 4 PSU ID Economics 304WD Homework Lesson 6 Goods Market Equilibrium in an Open Economy 85 points 1 45 points total We assume that the world consists of two large open economies USA and China USA Initial Conditions Cd 300 0 4 Y T 200rw Id 200 200rw Y 1000 T 200 G 275 China Initial Conditions CdF 450 4 YF TF 300rw IdF 250 300rw YF 1500 TF 300 GF 300 a What is the equilibrium interest rate that clears the international goods market Show all work 10 points rw 1 b Now calculate the levels of desired savings investment and net exports for each country at this equilibrium world real interest rate 5 points Round to the nearest two decimal places if needed US China SdUS SdCH IdUS IdCH NXUS NXCH 2 c Which country is spending beyond its means and which country is the saver What exactly do we mean by the phrase spending beyond its means in this context Be sure to define and use the word absorption in your answer and compare the level of absorption in each country to its income Explain 5 points d Draw two diagrams side by side with the US on the left and the China on right Locate this initial equilibrium as points A on both diagrams there are four point A s two on each diagram Be sure to label diagram completely 10 points for correct and completely labeled diagrams 3 Now China experiences an adverse productivity shock As a result China s output falls to 1400 e 10 points Resolve for the world real interest rate that clears the international goods markets along with the new Sd and Id for each country and add these results to your diagram labeling this new equilibrium as points B there are four of them 10 points rw US China SdUS SdCH IdUS IdCH 4 f 5 points Now comment on what has happened to the trade balance for each country and relate to the movie clip from Colbert about spending beyond our means Recall that Fareed Zakaria the guest suggested that we the US needed to go to alcoholics anonymous AA Are your results consistent with the US going to AA Why or why not Explain and please be specific 2 40 points total We assume that the world consists of two large open economies home and foreign Home Country Initial Conditions Cd 480 0 4 Y T 300rw Id 225 300rw Y 1500 T 300 G 300 Foreign Country Initial Conditions CdF 320 4 YF TF 200rw IdF 150 200rw YF 1000 TF 200 GF 275 a 5 points What is the equilibrium interest rate that clears the international goods market Show all work rw 5 b 5 points Now calculate the levels of desired savings investment and net exports for each country at this equilibrium world real interest rate Home Foreign S dH S dF IdH IdF NXH NXF 6 c 5 points Which country is acting like the US i e spending beyond its means and which country is acting like China i e the saver You must use and define absorption to get full credit d Draw two diagrams side by side with the Home country on the left and the Foreign country on right Locate this initial equilibrium as points A on both diagrams there are four point A s two on each diagram Be sure to label diagram completely 10 points for correct and completely labeled diagram 7 Now the foreign country conducts expansionary fiscal policy so that G rises by 50 to now equal 325 All else remains the same e 5 points Resolve for the world real interest rate and levels of saving investment that clears the international goods markets and add these results to your diagram labeling this new equilibrium as points B there are four of them 5 points rw Home Foreign S dH S dF IdH IdF 8 f 5 points What has happened to the trade balance for the foreign country and did the increase in G crowd out private investment If so how much investment was crowded out Work Explanation g 5 points Now let s pretend that the Government spending multiplier is 1 so that the increase in G by 50 resulted in Y rising by 50 from 1000 1050 On the next page resolve for the trade balance for each country Are these final results consistent with the foreign country going to AA the proposition put forth by Fareed Zakaria in the Colbert clip why or why not Please DO NOT add these results to your diagram just discuss them please don t ask what going to AA means we talked about it numerous times in the lesson review 9 rw Home Foreign S dH S dF IdH IdF Explanation 10


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PSU ECON 304 - ECON 304 HW 6 (2)

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