Consider a two-period small open economy populated by households and firms with a singlegood each period.The preferences of the representative household are described by the utility function u(c₁c₂) =(C₁C₂)² where c₁ and c₂ denote consumption in periods 1 and 2, respectively. In period 1, thehousehold receives an endowment of q₁ 1. In period 2, the household receives profits,denoted by T₂, from the firms it owns. In period 1, the household has access to financialmarkets where they can borrow or lend at the interest rate r = 10%. The household has azero asset holding position in period 1. Let the budget constraint in the first period be c₁ +b = 9₁, with b denoting assets purchased in the first period.Firms borrow in period 1 from the international financial market to invest in physical capitaland to produce final goods in period 2. Denote by d₁ the amount of debt taken by the firm inperiod 1. The production technology in period 2 is given by Q₂ = 410.5, where Q₂ and 1₁denote output in period 2 and investment in period 1, respectively.Both firms and households are subject to the same collateral constraint, with ₁ denoting thevalue of the collateral. Suppose that ê₁ equals 5. Assume that the economy's initial net foreignasset position is zero (bg = 0).Question 1: State the maximization problem of the firm, and compute the firm's optimal levelsof period-1 investment and period-2 profits. Provide intuition.Question 2: State the maximization problem of the representative household. Derive theassociated optimality conditions, and compute the equilibrium allocation of the countryconsumption, net foreign asset position (b1), the trade balance, and the current account.Provide intuition.Question 3: Suppose that a financial panic causes foreign banks to lower their assessmentof the value of the collateral. Specifically, suppose that ₁ falls from 5 to 1 for firms and from5 to 0 for households. Solve for the equilibrium levels of investment, consumption, the tradebalance, the current account, and the country's net asset position in period 1, and output andprofits in period 2. Provide intuition.

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Question 1: State the maximization problem of the firm, and compute the firm's optimal levels of period-1 investment and period-2 profits. Provide intuition.

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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