QUESTION 1. An ECONOMY WITH INVESTMENT (30 MARKS) Consider a two-period model of a small open economy with a single good each period. a Let preferences of the representative household be described by the utility function In C1 + In C2, where C and C2 denote consumption in periods 1 and 2, respectively. In period 1, the household receives an endowment of Q1 = 10. In period 2, the household receives profits, denoted by II2, from the firms it owns. Households and firms have access to financial markets where they can borrow or lend at the interest rate ri. (r is the interest rate on assets held between periods 1 and 2.) Firms invest in period 1 to be able to produce goods in period 2. The production technology in period 2 is given by Q2 = 2.4 x (11) 3 4 where Q2 and 11 denote, respectively, output in period 2 and investment in period 1. Assume that there exists free international capital mobility and that the world interest rate, p*, is 20% per period (i.e., p* = 0.2). Finally, assume that the economy's initial = net foreign asset position is zero (B* = 0). Based on the above information, answer the following questions. 2 ( (1) [15 marks] Find the current account in periods 1 and 2 (CA1 and CA2). (2) (15 marks] Now consider an investment surge. Specifically, assume that as a result of a technological improvement, the production technology becomes Q2 = 4.8 x (11) Find the current account balance (CA, and CA2). 3