The following greatly simplified problem will give you a sense of rational expectations models. All households in an economy are exactly alike. All want the same consumption year after year and will save or lend to get this. Household income in year one is $40,000, is $50,000 in year two, then it goes to $40,000 in year three, back to $50,000 in year four, and so forth, cycling between $40,000 and $50,000. Assume the interest rate is zero (this is only to make the problem very simple) and households want to consume all of their average income. The only way households can lend or borrow money is from overseas. (Note that when household income is $X, each household produces $X worth of goods.)

a. What will annual household consumption be?

b. In good years, what do households do with their savings? How is this reflected in net exports per household?

c. In bad years, how do households finance their consumption? How is this reflected in net exports per household?