Suppose there are two countries in the world and both can be

Suppose there are two countries in the world and both can be described by a simple Keynsian model. The Country 1 model is: And the Country 2 model is Assume exports of Country 1 are 240 and that exports of country 2 are 630. Find equilibrium incomes in the two countries. (Do not use export functions) What is the export function ofr country 1? What is the export function ofr country 2? Find equilibrium income ofr the world and ofr each economy.(using the export functions) How mu Ch is saved (private saving) in the two economies? What is the current account balance in each country? How mu Ch of the household savings in each country goes to purchase domestic private sector bonds (assume bonds are the only asset)? Government bonds? Bonds from the other country? Suppose country 1 embarks on a program of government spending increases and tax cuts. Set G1 =300 and T1 =50. Answer questions (c) to (f) using this new inofrmation. What impact does the increase in the government

Solution

(a) In each economy, without export function (closed economy),

Y = C + G + I

(1) Country 1:

Y1 = 0.8Yd1 + 200 + 200 = 0.8 x (Y1 - T1) + 400

Y1 = 0.8 x (Y1 - 100) + 400

Y1 = 0.8Y1 - 80 + 400

0.2Y1 = 320

Y1 = 1,600 [equilibrium income]

(2) Country 2:

Y2 = 0.5Yd2 + 200 + 180 = 0.5 x (Y2 - T2) + 380

Y2 = 0.5 x (Y2 - 200) + 380

Y2 = 0.5Y2 - 100 + 380

0.5Y2 = 280

Y2 = 560 [equilibrium income]

(b) Export function is: NX = X - M

(1) Country 1

NX1 = 240 - 0.4Yd1 = 240 - 0.4 x (Y1 - T1)

NX1 = 240 - 0.4 x (Y1 - 100)

NX1 = 240 - 0.4Y1 + 40

NX1 = 280 - 0.4Y1

(2) Country 2

NX2 = 630 - 0.4Yd2 = 630 - 0.4 x (Y2 - T2)

NX2 = 630 - 0.4 x (Y2 - 200)

NX2 = 630 - 0.4Y2 + 80

NX2 = 710 - 0.4Y2

(c) Equilibrium: Y = C + I + G + NX

(1) Country 1

Y1 = 0.8Y1 - 80 + 400 + NX1 = Y1 = 0.8Y1 + 320 + 280 - 0.4Y1

(1 + 0.4 - 0.8)Y1 = 600

0.6Y1 = 600

Y1 = 1,000

(2) Country 2

Y2 = Y2 = 0.5Y2 - 100 + 380 + NX2 = Y2 = 0.5Y2 + 280 + 710 - 0.4Y2

(1 + 0.4 - 0.5)Y2 = 990

0.9Y2 = 990

Y2 = 1,100

(d) Private saving, S = Y - C

(1) Country 1

S1 = Y1 - C1 = Y1 - 0.8Yd1 = Y1 - 0.8 x (Y1 - T1)

S1 = Y1 - 0.8 x (Y1 - 100)

S1 = Y1 - 0.8Y1 + 80

S1 = 0.2 x Y1 + 80 = 0.2 x 1,000 + 80 = 200 + 80

S2 = 280

(2) Country 2

S2 = Y2 - C2 = Y2 - 0.5 x (Y2 - 200)

S2 = Y2 - 0.5Y2 + 100

S2 = 0.5Y2 + 100 = (0.5 x 1,100) + 110 = 550 + 110 = 660

** Y1 and Y2 values for export-included GDP are used.

NOTE: First 4 sub-questions are answered.