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1) Explain how each of the following transactions would enter the U.S. balance of payments accounts. Discuss only the transactions described. Do not be concerned with possible offsetting transactions.
a) The U.S. government sells F-16 fighter planes to Israel.
b) A London bank sells yen to, and buys dollars from, a Swiss bank.
c) The Federal Reserve sells yen to, and buys dollars from, a Swiss bank.
d) A U.S. collector buys ancient artifacts from Egypt.
e) A U.S. oil company buys insurance from a Canadian insurance company to insure its oil rigs in the Gulf of Mexico.
f) A New York bank receives interest on loans it has made to Brazil.
g) A U.S. company borrows from a British bank.
2) Consider two large economies, the home economy and the foreign economy. In the home country the following relationships hold:
desired consumption, Cd = 320 + 0.4(Y T) 200rw;
desired investment, Id = 150 200rw;
output, Y = 1000;
taxes, T = 200;
government purchases, G = 275.
In the foreign country the following relationships hold:
desired consumption, Cdfor = 480 + 0.4(Yfor Tfor) 300rw;
desired investment, Idfor = 225 300rw;
output, Yfor = 1500;
taxes, Tfor = 300;
government purchases, Gfor = 300.
a) What is the equilibrium interest rate in the international capital market? What are the equilibrium values of consumption, national saving, investment, and the current account balance in each country?
b) Suppose that in the home country government purchases increase by 50 to 325. Taxes also increase by 50 to keep the government’s deficit from growing. What is the new equilibrium interest rate in the international capital market? What are the new equilibrium values of consumption, national saving, investment, and the current account balance in each country?
3) A small island nation is endowed with indestructible coconut trees. These trees live forever and no new trees can be planted. Every year $1 million worth of coconuts fall off the trees and can be eaten locally or exported to other countries. In past years the island nation ran current account surpluses and capital and financial account deficits, acquiring foreign bonds. It now owns $500,000 of foreign bonds. The interest rate on these bonds is 5% per year. The residents of the island consume $1,025,000 per year. What are the values of investment, national saving, the current account balance, the capital and financial account balance, net exports, GDP, and GNP in this country?
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