Chapter1: Making Economics Decisions
Section: Chapter Questions
Problem 1QTC
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Question
![The Model of A Sudden Stop
Consider a two-period, small, open economy. In period 1, households receive an endowment of 6
units of tradable goods and 9 units of nontradable goods. In period 2, households receive 13.2 units
of tradables and 9 units of nontradables (QT = 6, Q = 13.2, and QN = QN = 9). Households start
period 1 with no assets or liabilities (B; = 0). The country enjoys free access to world financial
markets, where the prevailing interest rate is 10 percent (r* = 0.1). Suppose that the household's
preferences are defined over consumption of tradable and nontradable goods in periods 1 and 2,
and are described by the following utility function, In Cf + In CN + In C + In C", where C and
CN denote, respectively, consumption of tradables and nontradables in period i = 1,2. Let pi and
P2 denote the relative prices of nontradables in terms of tradables in periods 1 and 2, respectively.
1.
Solve for Cf, C, CN, CN, P1, and p2, and calculate the equilibrium levels of the
current account balance in periods 1 and 2 (CA, and CA2).
2.
Let us sketch a scenario like the one that took place during the Argentine debt
crisis of 2001 by assuming that because of fears that the country will not repay its debts
in period 2, foreign lenders increased the interest rate from 10 percent to 100 percent (now](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F22773a1b-4bae-4ea8-8bdd-ce7da6ba345b%2F1318a9f5-89ea-4ae7-bf19-afecbc731c00%2Fzmbuheq_processed.jpeg&w=3840&q=75)
Transcribed Image Text:The Model of A Sudden Stop
Consider a two-period, small, open economy. In period 1, households receive an endowment of 6
units of tradable goods and 9 units of nontradable goods. In period 2, households receive 13.2 units
of tradables and 9 units of nontradables (QT = 6, Q = 13.2, and QN = QN = 9). Households start
period 1 with no assets or liabilities (B; = 0). The country enjoys free access to world financial
markets, where the prevailing interest rate is 10 percent (r* = 0.1). Suppose that the household's
preferences are defined over consumption of tradable and nontradable goods in periods 1 and 2,
and are described by the following utility function, In Cf + In CN + In C + In C", where C and
CN denote, respectively, consumption of tradables and nontradables in period i = 1,2. Let pi and
P2 denote the relative prices of nontradables in terms of tradables in periods 1 and 2, respectively.
1.
Solve for Cf, C, CN, CN, P1, and p2, and calculate the equilibrium levels of the
current account balance in periods 1 and 2 (CA, and CA2).
2.
Let us sketch a scenario like the one that took place during the Argentine debt
crisis of 2001 by assuming that because of fears that the country will not repay its debts
in period 2, foreign lenders increased the interest rate from 10 percent to 100 percent (now
![r* = 1.00). Calculate the equilibrium levels of the current account balance in periods 1 and
2 (CA, and CA2).
3.
Consider the same situation as in Part 2 of this question. Suppose the Inter
American Development Bank (IADB) decided to implement a transfer (gift) to Argentina
to ameliorate the effects of the external crisis. Specifically, suppose that the IADB gives
Argentina a transfer of F units of tradable goods in period 1. Use the utility function given
above to compute the size of F that would make Argentineans as happy as in the no-crisis
scenario.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F22773a1b-4bae-4ea8-8bdd-ce7da6ba345b%2F1318a9f5-89ea-4ae7-bf19-afecbc731c00%2Fz7xt6zc_processed.jpeg&w=3840&q=75)
Transcribed Image Text:r* = 1.00). Calculate the equilibrium levels of the current account balance in periods 1 and
2 (CA, and CA2).
3.
Consider the same situation as in Part 2 of this question. Suppose the Inter
American Development Bank (IADB) decided to implement a transfer (gift) to Argentina
to ameliorate the effects of the external crisis. Specifically, suppose that the IADB gives
Argentina a transfer of F units of tradable goods in period 1. Use the utility function given
above to compute the size of F that would make Argentineans as happy as in the no-crisis
scenario.
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