Consider a small country that wants to consumption smooth as much as possible. If no invest- ment is made, output at t = 0 will be 100 and output at t = 1 will be 100. If the country invests 1 unit today, it can produce 110 units tomorrow. Finally, assume that the intertemporal utility at home is

u(c0) + u(c1) where = 1 , r is the worl interest rate, u is concave (i.e. consumers are risk averse and

1+r want to smooth consumption).

(a) If the country cannot borrow or lend on world markets, will it undertake the investment? Explain.

(b) Suppose that the country can borrow and lend at r = 2%. Will the country undertake the investment?