Assignment No.

MACRO ECONOMICS

Submitted By

Abhishek Gautam WMG XIX 192001

Group 1 Consider an economy described by the following equations: Y = C + I + G + NX, Y = 5000, G = 1000, T = 1000, C = 250 + 0.75(Y-T), I = 1000 50r NX = 500 - 500, r = r* = 5. a. In this economy, solve for national saving, investment, the trade balance, and the equilibrium exchange rate Solution: National Saving S=Y-C-G S=5000-[250+0.75(5000-1000)]-1000

S=750 I= 1000-50r I=1000-50(5)=750 Trade Balance, NX= S-I NX=750-750=0 Equilibrium exchange rate NX=500-500 => =1 b. Suppose now that G rises to 1250. Solve for national saving, investment, the trade balance, and the equilibrium exchange rate. Explain what you find. Solution: National Saving S=Y-C-G S=5000-[250+0.75(5000-1000)]-1250 S=500 I=1000-50r= 750 Trade Balance NX=500-750=250 Equilibrium exchange rate NX=500-500 G =1.5 S real interest rate Investment

Earli er 1000 750 5 750

Later 1250 500 5 750 Increase d Decreas ed same same

Now, domestic investment exceeds domestic saving, so many of this investment must be financed by borrowing from abroad. This capital inflow is accomplished by reducing net exports, and appreciation of currency. c. Now suppose that the world interest rate rises from 5 to 10 per cent. (G again 1000.) Solve for national saving, investment, the trade balance, and the equilibrium exchange rate. Explain what you find. Solution: National Saving S=Y-C-G S=5000-[250+0.75(5000-1000)]-1000 S=750 I=1000-50r= 500 Trade Balance NX=750-500=250

 Equilibrium exchange rate NX=500-500 =0.5 Saving is unchanged as 750, but the higher world interest rate reduces investment. Now capital outflow is accomplished by running a trade surplus, which requires the currency depreciate.