3. Why Doesn't Capital Flow to Developing Countries? The Canadian Econ- omy is described by the following information on output, consumption, fiscal policy and investment: Y = 5,000 C = 250 +0.75(Y 9 T) T = 1,000 G = 2,000 1(r) = 1,000 0 50r Canada is a small open economy. a) If the world interest rate is equal to 5, what are net exports? Is Canada lending or borrowing from the rest of the world? b) The country of Sri Lanka has a lower capital stock than Canada. It has output, Y' = 2,500, government spending equal to 1,000 and taxes equal to 500. The consumption function is the same as Canada, however, the investment function is: I'(r) = 2,000 9 50r What are net exports for Sri Lanka in this case? c) Compare investment in Canada and Sri Lanka. Which country has a higher level of investment? Why do you think this is? Hint: Think about what determines the demand for capital. d) The Case Study on page 145 of your text suggests that in reality capital does not flow to countries like Sri Lanka, but instead to countries like Canada. One reason for this might be a risk premium, so that the real interest rate paid by Sri Lanka is: r=p* +0 Where p* is the world interest rate of 5 percent and is the risk premium. If you observe that NX' = 0 for Sri Lanka, what must the risk premium be