Consider a Large Open Economy That Has a Positive Current

question 42

Essay

Consider a large open economy that has a positive current account balance.
(a)Suppose the domestic government increases the tax rate on firm revenues.Draw a diagram to explain the effects on the world real interest rate,saving in each country,investment in each country,and the current account balance in each country in equilibrium.Explain your work.
(b)In addition to the tax increase in part (a),suppose now that the foreign government increases lump-sum taxes on individuals.Draw a new diagram to incorporate the overall effects of both tax changes and explain the effects (from the initial equilibrium with neither tax change)on the world real interest rate,saving in each country,investment in each country,and the current account balance in both countries.Explain your work.

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Definitions:

Grams

A unit of mass in the metric system, used to measure small quantities of substances.

Standard Weight

A term often used to denote average or ideal weight based on height, age, and gender, according to health standards.

Hertz

The unit of frequency in the International System of Units (SI), equal to one cycle per second.

Absolute Threshold

The smallest quantity of a stimulus that an individual can detect.