Assignment:
Consider the following model:
(1) Y = C + I + G + X - M
(2) C = 300 + 0.5Y
(3) I = 200
(4) G = 200
(5) X = 200
(6) M = 150 + 0.25 Y
Please answer the following questions:
a. How much is equilibrium income or output (Y)?
b. What is the equation for the saving function in this economy?
c. What are the values of MPC, MPS and MPM?
d. What is the value of spending multiplier for this economy?
e. At equilibrium income is the trade balance in deficit or surplus? By how much?
f. In an effort to reduce the trade deficit government decides to cut its spending by 100. What will be the impact on the trade balance?
g. Another way to improve the position of trade balance is to encourage exports. Suppose government provides subsidies to exporters that result in an increase in exports by 100. What will happen to the trade balance and by how much?
Practice Problem Key
1. Suppose you are in charge of investing 300 million dollars either in the U.S. or in Japan over one year period. Given the following information where would you invest?
Spot exchange rate is 120 yen per dollar.
One year forward rate is 115 yen per dollar
Annual interest rate in Japan 2%
Annual interest rate in the U.S. 2.5%
2. Suppose you are in charge of investing 300 million dollars either in the U.S. or in Japan over a three months period. Given the following information where would you invest?
Spot exchange rate is 120 yen per dollar.
Three months forward rate is 115 yen per dollar
Annual interest rate in Japan 2%
Annual interest rate in the U.S. 3%
3. Now suppose you are to invest your 300 million dollars either in the U.S. or in the U.K. for a six months period. Given the following information where would invest?
Spot exchange rate is 2 dollar per pound
Six months forward exchange rate is 2.1 dollar per pound
Annual in interest rate in the U.S. is 5%
Annual interest rate in the U.K. is 4%.