Home maximizes its lifetime discounted utility subject to the budget constraint it faces, i.e.,max U = In C₁ + 0.7 In C₂such thatC₁ + B₂ = 700C₂ = 700 + (1+r) B₂.Suppose that the autarky (without trade) interest rate r = 0.04 and the world interest rate, or the world equilibrium interestrate r = 0.03.In autarky, consumption in period 1 equals (1)and consumption in period 2 equals (2)With trade, consumption in period 1 equals (3)while consumption in period 2 equals (4)Sincethe autarky interest rate is (5)than the world interest rate, the relative price of period 1 consumption in autarkywill be (6)than its price with trade. In line with the Principle of Comparative Advantage, the domestic economyin period 1 and (8)in period 2. The first-period current account balance is (9)will (7)while the second-period current account balance is (10)Now suppose that both period 1 and 2 incomes decrease by 100. Period 1 consumption will now equal (11)while period 2 consumption will equal (12)The new first-period current account balance is (13)17 while the new second-period current account balance is (14)

utility subject to the budget constraint it faces, i.e., max U = In C₁ +0.7 In C₂ such that C₁ + B₂ = 700 C₂ = 700 + (1 + r) B₂. Suppose that the autarky (without trade) interest rate r = 0.04 and the world interest rate, or the world equilibrium interest rate r = 0.03.

utility subject to the budget constraint it faces, i.e., max U = In C₁ +0.7 In C₂ such that C₁ + B₂ = 700 C₂ = 700 + (1 + r) B₂. Suppose that the autarky (without trade) interest rate r = 0.04 and the world interest rate, or the world equilibrium interest rate r = 0.03.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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