Question 2 (30 points) Topics 3, 4 & 5 Suppose the world consists of only one pair of open economies, country A and country B, and these countries Moade with each other. Country A only produces food whose output is measured in standard units, where one unit of YA is equal to 250 kilograms of food. Country B only produces clothing in standard units, where one unit DfYn is equal to 10 kilograms of clothing. The table below provides some selected information about the economies of these countries. Keep your answers to at: least 4 decimal places. Country A Country B Production mction: YA = 3xKJLM Capital stock: K = 500 Labour supply: L = 500 Production function: Y3 = Ko'mLM\" Capital stock: K = 850 Labour supply; L = 850 Cons Investment function: I= 304 Sr 'onlnction1C=15l}+0.5 'onmction:C=llO+0.65YT InvestIn-t function: I = 150 9r Gov't sector: G = 100 8: T =10t] Net ex ort ftmction: N'X = 841 9752 Monetary sector: Real money demand = L{r, Y} = 0.3'1' ltIIr Nominal price level = l Gov'tsector: G: 110 &T= llt] Monetary sector: Real money demand = [{r, Y} = 0.9Y 2|]0r Nominal price level = l Use the longrim classical model of an open economy to answer the following questions. Both countries have perfect nancial capital mobility and no risk premium. Also, expected inflation is zero in both countries. Note : I Interest rates, i and r, are expressed in percentage points, i.e., ifr = 15, then r = 7.5%. I Since there are only two open economies, both are large open economies. I Think about: what holds true when we add up all countries' net exports together. a) Determine the longrun equilibrium level of food and clothing production. (4 points} MGEBGS Assignment 2 (Fall 2020) 2 b) Suppose absolute purchasing power parity holds for these countries. For each lm, determine the longrun equilibrium levels of: I The trade balance; I The domestic nominal money supply; I The real exchange rate (in the usual orientation # of foreign per domestic, arm); I The nominal exchange rate (in the usual orientation of it of foreign currency per domestic may); I The domestic real rate of interest; I The real wage rate of labour and real rental rate of capital; I The unemployment rate; and I Output per worker. Support your answer with one set of diagrams, one for the (Colmtry A) loanable ftmds market and one for the (Country A) foreign exchange market. Which country has a better standard ofliving'? (11 points) c) Suppose the government of country A decides to implement a new law that imposes a minimum real wage of 1.75. Redo parts (a) and (b). Explain in words which country has a better standard ofliving 3: why. (15 points} Support your answer with one NEW set of diagrams, one for the (Country A) loanable ftmds market and one for the {Country A) foreign exchange market. Be sure to label the initial and new longrun equilibrium points and provide an explanation on whetherthe values of variables of interest change or remain lmchanged. Note: There is no need to do any calculation. Written explanation will be su'icient
