Question #4

4. (40 pts). Consider a small open economy that is currently running a trade surplus. (a) Show this economy on the graph using a saving-investment diagram for a small open economy. Remember to label a_H lines and axes. After you draw the graph, answer the following questions: {b} Is the world interest rate higher or lower than the real interest rate that would prevail if this were a closed economy? How do you know it? (c) What would be the effects of an autonomous decrease in investment (as a result of investors' pessimism, for example} on equilibrium saving, investment, the real interest rate, and the trade balance? Show these effects on your graph above. (d) Now assuming that this small economy is closed {instead of open), what would be the effects of an autonomous decrease in investment (as a result of investors' pessimism, for example) on equilibrium saving, investment, and the real interest rate? Show these effects on your graph below. Would they be different from the effects in part (c)