Problem 1: Suppose that a financial crisis hits Econland and reduces the wealth of its households. Assume standard shapes for the production, labor demand, labor supply, saving and investment curves. Further, assume that Econland is a closed economy.

a) Illustrate the effect of the change in S = S(Y1,Y2,W) due to the reduction in wealth on the saving-investment diagram for the market of funds.

b) What will be the resulting change in r and I? Explain.

c) If the fall in household wealth makes workers supply more labor for any given real wage, how

will the reduction in wealth affect the equilibrium level of employment?

d) As a result, will the marginal product of labor, MPN, increase or decrease? Explain.

e) How will the change in employment affect output? Illustrate the effects on the labor market diagram and national output diagram.

f) Will the (temporary) change in GDP change S(.) in the same or opposite direction as the initial wealth reduction did?

Now suppose Econland signs a couple of trade agreements and becomes an open economy. The international real interest rate is below Econland's original real interest rate.

g) Is Econland a net lender or net borrower?

h) Illustrate the effect of the change in S(.) due to the reduction in wealth on the saving- investment diagram for the market of funds.

i) Will the current account balance increase or decrease?