Question

The country of Albanystan (country A) forms a small open economy on its own. It has savings S_A=30+300r and investment I_A=80-200r. If r=0.2, is country A a borrower or a lender? Below what interest rate would country A be a borrower? The country of Bostonland (country B) decides to join and together they form a large open economy with S_B=40+100r and I_B=5-500r What is the equilibrium interest rate? What is CA_A,CA_B? Which country borrows and which country lend?

Answer 1

A) r=0.2 Savings=30+300*0.2=90 And investment = 80-200*0.2=40 Hence savings > investment Hence the country has enough savings to fund the investments hence the country is a lender. b. To the country be a borrower, Investment > savings Or, 80 - 200r > 30 + 300r Or 500r<50 Or r<0.1 Hence below r=0.1 the country will be a borrower. a.) The country of Boston Land or country B has a national savings function as SB=40+100r and the investment curve as IN=5-500r where r represents the domestic interest rate in country B. Now, based on the equilibrium condition, the national savings is equal to the aggregate investment. Therefore, based on the equilibrium conditioner savings-investment identity, it can be stated, in this case: SB=IB 40+100r=55-500r 500r+100r=-40+5 600r=-35 r=-35/600 r=-0.058 approximately The equilibrium interest rate in country B is -0.058 approximately.

b. Now, plugging the value of the equilibrium interest rate into the national savings function of country B, we can get: SB=40+100r SB=40+100*(-0.058) SB=40-5.8 SB=34.2 Therefore, the equilibrium national savings and the investment level in country B is 34.2. c. As the savings level of the country B is less than the investment level it will become a net borrower in the international market implying that it has financial debt in the international financial market and if the investment level of the country is higher than its national savings, the country will be net lender in the international market

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