Consider the two-period small open economy model, which takes the world interest rate, r, as given. Q1 - C1 - I1 = B1* (1) Q2 + rB1* - C2 = -B1* (2) K2 = K1 + I1 (3) Where Q is output, C is consumption, I is investment, r is interest rate, K is capital and B* is the net claims of a countries residents on residents in the rest of the world. (i.e. if B* is positive the country is a net creditor) Recall that depreciation is set equal to zero and labour force assumed constant (all that can be chosen is the I1. ) (a) Assume B0* = B2* =B1*=0 and draw the transformation curve graphing Q1- I1 against Q2. . (b) Optimal investment will be given by MPK2 = 1+r. and optimal consumption will be given by - (1+)V'(C1)/V'(C2) = -(1+r) Hence illustrate the trade balance on your diagram.. (c) Use the diagram to illustrate how different kinds of shocks will affect the trade balance. Explain