1)Suppose we have an emerging economy with a GDP of $150 billion. It borrows $20 billion which it plans to repay next year. The costs of default are 20% of GDP. Consider 2 scenarios:

Scenario A: GDP next period is $150 billion - the real interest rate is 10%

Scenario B:GDP next period is $110 billion - the real interest rate is 25%

a)Assuming scenario A, is it in the best interest of this emerging economy to pay its debt or default? Show all work and explain.

b)Now draw a repayment vs. default diagram with consumption on the vertical axis and GDP on the horizontal axis (as in the textbook and lecture).Assuming scenario A, label this as point A.Similarly, assuming scenario B, label this as point B.Be sure your diagram is completely labeled with a consumption if you default line, a consumption if you pay line, slopes labeled as well as repayment threshold level of GDP (Y_T ) and the default / repayment zones.Please show your work calculating Y_T.

c)Assuming Scenario B, is it in the best interest of this emerging economy to pay its debt or default?Show all work and explain.

d)Now draw a repayment vs. default diagram with consumption on the vertical axis and GDP on the horizontal (as in the textbook and lecture).Assuming scenario A, label this point as point A.Similarly, assuming scenario B, label this as point B.Be sure your diagram is completely labeled with a consumption if you default line, a consumption if you pay line, slopes labeled as well as repayment threshold level of GDP (Y_T ) and the default / repayment zones.Please show your work calculating Y_T.

e)Explain the intuition (the economics) as to why your decision to default/repay changed from scenario A to scenario B.

Name all the factors that you can think of that would lower the repayment threshold level of GDP (Y_T ) and the intuition as to why each factor would lower Y_T.