1. Consider a two-period, small, open economy with free capital mobility. Households are endowed with 10 units of tradable in period 1 and 10 units in period 2 (QT

1 = 10 and

QT
2 = 10). The world interest rate is 0, r

∗ = 0, the nominal exchange rate, defined
as the price of foreign currency in terms of domestic currency, is fixed and equal to 1 in both periods (S1 = S2 = 1). Suppose that the foreign-currency price of tradable
goods is constant and equal to one in both periods, and that the law of one price holds for tradable goods. Nominal wages are downwardly rigid. Specifically, assume that the
nominal wage in periods 1 and 2, measured in terms of domestic currency, can not fall below the past wage rate, Wi ≥ Wi?1 for i = 1, 2, with W0 = 5 given. Suppose the
economy starts period 1 with no assets or debts carried over from the past (B∗
0 = 0).
Suppose that the householdOs preferences are defined over consumption of tradable and ̃ nontradable goods in periods 1 and 2, and are

ln C^T₁ + ln C^N₁ + ln C^T₂ + ln C₂

where C
T
1
and C
T
2 denote consumption of tradables in periods 1 and 2, respectively,

and C
N
1
and C
N
2 denote consumption of nontradables in periods 1 and 2. Let p1 and p2 denote the relative prices of non- tradables in terms of tradables in periods 1 and 2,
respectively. Households supply inelastically h ̄ = 1 units of labor to the market each period. Finally, firms produce nontradable goods using labor as the sole factor input.
The production technology is given by
Q^N₁ = h^ª₁

and

Q^N_{2 =} h^ª₂

in periods 1 and 2, respectively, where QN
i
and hi denote, respectively, non- tradable
output and hours employed in period i = 1, 2. The parameter α is equal to 0.5.

(a) Compute the equilibrium level of consumption of tradables and the trade balance in periods 1 and 2. Show your work. Interpret your findings.
(b) Compute the equilibrium levels of employment and nontradable output in periods 1 and 2

Answer rating: 100% (QA)

C T 1 10 B 1 S 1 C T 2 10 B 2 S 2 Y 1 C N 1 C T 1 B 1 S 1 10 B 1 Y 2 C N 2 C T 2 B 2 S 2 10 B 2 NX 1 ... View the full answer