Consider an economy described by the following equations:

Y = C + I + G + NX

Y = 18,500; G = 4,000; T = 2,000

C = 750 + 3/4 (Y - T)

I = 1,000 - 50r

CF = 750 - 25r

NX = 1,825 - 150

(a) In this economy solve for consumption, private and public saving, national saving, investment, the trade balance, the net capital outflow (net foreign investment), the real interest rate and the real exchange rate.

(b) The demand of funds for foreign direct investment is in reality a function of the domestic real interest rate, r, and the world real interest rate, r*, given by: CF = 750 - 50r + 25r*. Confirm that if r = r* at the real interest rate you found in (a) you get the same solution as in (a).

(c) The world interest rate increases to r* = 10. Solve for consumption, private and public saving, national saving, investment, the trade balance, the net capital outflow (net foreign investment), the domestic real interest rate, and the real exchange rate. (Hint: To solve you need CF as a function of only r, so use the value of r* in the CF function to leave it like that and solve the model.)

(d) What can you concur that happens in a large open economy in the long run if the world interest rate increases relative to the domestic real interest rate with respect to what you've found in part (c)?