The following equations describe the macro economy of Country A.  Assume that

     GDP and GNI are equal.  They are denoted Y.  Throughout the question we will

     assume that there is full employment, so that Y is fixed.  The interest rate (r) is

     expressed in percent.  Use the information to answer the questions below.  (16 pts)

              Y = 5000

              C = 800 + .75(Y-T) – 100r

               I = 825 – 50r

              G = 600, T = 400

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       a.  If Country A has a closed financial system with respect to the rest of the world

                 (i.e., doesn’t allow borrowing or lending with other countries), what will the

                 interest rate be in Country A?  How much domestic investment spending (I)

                 will there be?  (Hint:  You will find it helpful to derive the national saving

                 function using S = Y – C – G).

Country A has a closed financial system,  

C = 800 + .75(Y-T) – 100r=4250-100r

Y=C+I+G=4250-100r+(825-50r)+600=5000  →r=4.5  the interest rate be 4.5%

                I = S= Y – C – G=5000-(4250-100r)-600=600

       b.  Continuing to assume that the financial system is closed, suppose that in an

                 effort to balance the government budget, government consumption

                 expenditures (G) are reduced from 600 to 400.  What will the new interest rate

                 be?  What will happen to investment spending?   

        Country A has a closed financial system,  

Y=C+I+G=4250-100r +(825-50r)+400=5000  →r=3.17

                     I = S= Y – C – G=5000-(4250-100r)-400=666.5

       c.  Go back to the original equations and conditions of the problem (with G equal

                 to 600) but assume that Country A has an open capital market and is perfectly

                 integrated with a world financial system whose interest rate is 3%.  Assume

                 that Country A is relatively small in the world, so that developments inside of

                 Country A have a negligible effect on the world interest rate.  Will Country A

                 have net capital inflow or outflow?  In what amount?  How much investment

                 spending will there be?

                       Country A has a open financial system,

Country A will have net capital inflow

                     X-M= Y-(C+I+G)=5000-(4250-100*3+825-50*3+600)=-225

                   I = 825 – 50r=825-50*3=675

       d.  Continue with the situation described in part (c), where the country is part of a

                 large global financial system, and reconsider the effects of reducing

                 government spending to 400.  What will happen to the country’s net capital

                 flows?  What will the new level of domestic investment spending be?

                      Country A has a open financial system,

                     X-M=(IP-IR)+(KO-KI)= (IP-IR)+(S-I) →

(KO-KI)= (S-I)= Y-(C+I+G)=5000-(4250-100*3+825-50*3+400)=-25