Consider two large open economies, the home economy and the foreign economy. In the home country the following relationships hold:
Desired consumption, Cd = 320 + 0.4(F - T) - 200rw;
Desired investment, Id = 150 - 200rw;
Output, Y = 1000;
Taxes, T = 200;
Government purchases, G = 275.
In the foreign country the following relationships hold:
Desired consumption, CdFor = 480 + 0.4(YFor - TFor) - 300rw;
Desired investment, 7dFor = 225 - 300rw;
Output, YFor = 1500;
Taxes, TFor = 300;
Government purchases, GFor = 300.
a. What is the equilibrium interest rate in the international capital market? What are the equilibrium values of consumption, national saving, investment, and the current account balance in each country?
b. Suppose that in the home country government purchases increase by 50 to 325. Taxes also increase by 50 to keep the deficit from growing. What is the new equilibrium interest rate in the international capital market? What are the new equilibrium values of consumption, national saving, investment, and the current account balance in each country?