Posted: September 13th, 2017
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The paper needs to be answered showing all necessary diagrams and calculations. Further instructions are on the paper.
Suppose the world consists of only one pair of open economies, country A and country B, and these countries only trade with each other. Country A only produces food whose output is measured in standard units, where one unit of YA is equal to 1,000 kilograms of food. Country B only produces clothing in standard units, where one unit of YB is equal to 100 kilograms of clothing. The table below provides some selected information about the economies of these countries. Keep your answers to at least4 decimal places.
Country A | Country B |
Production function: YA = 3xK0.50L0.50
Capital stock: K = 1000 Labour supply: L = 1000 |
Production function: YB = K0.50L0.50
Capital stock: K = 900 Labour supply: L = 900 |
Consumption function: C = 500 + 0.70(Y-T) | Consumption function: C = 150 + 0.65(Y-T) |
Investment function: I = 400 – 25r | Investment function: I = 200 – 50r |
Gov’t sector: G = 500 & T = 501 | Gov’t sector: G = 110 & T = 110 |
Net export function: NX = 850 – 925ε | |
Monetary sector:
Real money demand = = 0.65Y – 200r Nominal price level = 1.2 |
Monetary sector:
Real money demand = = 0.9Y – 200r Nominal price level = 1.04 |
Use the long-run classical model of an open economy to answer the following questions. Both countries have perfect financial capital mobility and no risk premium.
Hint: Since there are only two open economies, both are large open economies.
Support your answer with one set of diagrams, one for the (Country A) loanable funds market and one for the (Country A) foreign exchange market. Which country has a better standard of living? (11 points)
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