Problem Set 3
Prof. Nordhaus and staff
Economics 122a: Fall 2010
Due: Wed. October 6 in class
Problem Set 3 (Ungraded)
Please put the name of your section leader and section time on your problem set.
Make sure that the work is your own. You may consult with others, but you may
not copy their answers or use their ideas.
Remember that it is harder to answer something in 100 words than 200 words. Accuracy
is silver, but brevity is golden!
1. Suppose that you spent Junior Year in France in 2008. You spent 50,000 Euros
in Paris on your tuition, lodging, and croissants, which you borrow from Yale
Student Loans.
a. Define the financial account balance.
b. Draw up your personal balance of payments account that reflects these
transactions (note that there is no unique answer on the financial
account, so you need to be clear about your assumptions).
c. Does your current account balance your financial account? Explain
why in a sentence.
(Note: Mankiw calls these “the trade balance” and “net capital outflow.”
For a brief explanation of current definitions, you can read a short
definition on the short note in the reading list.)
2. At the G-20 Summit in South Korea in July 2010, countries resolved to correct
the international saving-investment imbalance as follows:
Sound fiscal finances are essential to sustain recovery, provide flexibility
to respond to new shocks, ensure the capacity to meet the challenges of
aging populations, and avoid leaving future generations with a legacy of
deficits and debt. Advanced economies have committed to fiscal plans
that will at least halve deficits by 2013 and stabilize or reduce government
debt-to-GDP ratios by 2016.
Assume that a small open advanced country takes steps to meet the goals
outlined above. Explain the effect of these steps taken by the country on its
domestic interest rates, net capital outflow, real exchange rate, and net
exports.
3. Mankiw, Chapter 5, problem 2, p. 151, parts (a) and (b). In addition, do the
following:
(c) Suppose that G is again 1,000, and the country has a disputed election,
followed by riots and strikes. International investors will now only invest
if they receive a risk premium of 5 points above the world interest rate.
What is the domestic real interest rate for the country? What is the effect
of the election/riots/strikes on investment, national savings, trade
balance, and the equilibrium exchange rate?
4. Do Mankiw, Chapter 5, Appendix, problem 1, p. 162. (This problem
requires you to study the large open economy in the appendix, which we
did not cover in class, but will be at least briefly covered in sections.)