Consider a small open economy populated by N people with preferences u(c1i,c2i)
ID: 1189206 • Letter: C
Question
Consider a small open economy populated by N people with preferences u(c1i,c2i) = ln( c1i)+ ln(c2i) for i =1 ,2,...,N. Each person has a potentially dierent earnings stream (y1i,y2i).
(a) Calculated the current period demand function for each person i, cD 1 (R,y1i,y2i).
(b) Calculate the aggregate demand for current period consumption and demonstrate that it only depends on the time path of GDP (and not on how the GDP is distributed across people).
(c) Calculate the desired saving function for each person, sD i . Now, assume that a fraction of the population have an income stream (y1,0); and that the remaining fraction (1) have an income stream (0,y2). In a closed economy version of this model, aggregate net saving must sum to zero. Use this condition to derive an expression for an equilibrium real interest rate R that will equate the supply and demand for credit. How does R depend on parameters? Explain.
Explanation / Answer
Consider a small open economy populated by N people with preferences u(c1i,c2i)