Question
Suppose brightland is a small open economy. Assume initial external wealth W(w in year -1) is 0 and consumption is the only source of demand;
Suppose brightland is a small open economy. Assume initial external wealth W(w in year -1) is 0 and consumption is the only source of demand; G=0, I=0, NUT=0 = KA=0 and no net labor income so NFIA=r*W. Further, in year 0; Q=100, C=100, I=0, TB=0. and W=0. Suppose there is an investmen shock(no output shock)> Brightland now invests $16 in year 0 by borrowing $16 from the rest of the world at a world real interest rate r* of 5%. THere is no further borrowing or investment after this. The projects start to pay off 5 units of output ($5) in year 1 and continue to pay off all years thereafter. Interest is paid in perpetuity, in year 1 and every year thereafter. In addition, assume that if the projects are not done, then GDP=Q=C=$100 in all years, so that PV(Q)=PV(C).
A. What is brightlands Q=GDP in year 0, year 1 and later years? What is the new PV(Q) in dollars?
B. At year 0, what is the new PV(I) in dollars? Therefore, what does the LRBC say is the new PV(C) in dollars?
C. Assume that brighland is consumption smoothing. What is the percent change in PV(C)? What is the new level of C in all years? Is brightland better off?
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