= = - Problem 2. The Mexican Tequila Crisis of 199495. The domestic economy is Mexico. The currency of Mexico is the peso. Real GDP is constant and equal to Y = 2500. The consumption function is C= 100+0.8YD + 1000r where Yp is disposable income. Taxes are T = 500, no transfers and no public debt. The budget deficit is 200. The investment demand is I 2100 5000r. The net export function is given by NX = 1500 100RER where RER is the real exchange rate. The country can freely borrow and lend internationally at rate pW = 6%. Net factor payments are zero. (A) Find the initial equilibrium: find savings S, investment I, current account CA, net export NX and the real exchange rate RER. Is there net capital inflow or net capital outflow? Is there trade surplus or trade deficit? = (B) Foreign investors lose confidence in solvency of the Mexican government, and they demand a higher rate of return equal to 26%. Find the new equilibrium (S, I, CA, NX, RER). Is there now capital inflow or capital outflow? (C) On two diagrams (the loanable funds market and the foreign exchange market), show the initial situation and the new equilibrium. (D) Using plain English, explain how the economy transitions between the two equilibria. = = - Problem 2. The Mexican Tequila Crisis of 199495. The domestic economy is Mexico. The currency of Mexico is the peso. Real GDP is constant and equal to Y = 2500. The consumption function is C= 100+0.8YD + 1000r where Yp is disposable income. Taxes are T = 500, no transfers and no public debt. The budget deficit is 200. The investment demand is I 2100 5000r. The net export function is given by NX = 1500 100RER where RER is the real exchange rate. The country can freely borrow and lend internationally at rate pW = 6%. Net factor payments are zero. (A) Find the initial equilibrium: find savings S, investment I, current account CA, net export NX and the real exchange rate RER. Is there net capital inflow or net capital outflow? Is there trade surplus or trade deficit? = (B) Foreign investors lose confidence in solvency of the Mexican government, and they demand a higher rate of return equal to 26%. Find the new equilibrium (S, I, CA, NX, RER). Is there now capital inflow or capital outflow? (C) On two diagrams (the loanable funds market and the foreign exchange market), show the initial situation and the new equilibrium. (D) Using plain English, explain how the economy transitions between the two equilibria