Consider a small open economy that is in equilibrium with a current account surplus. (a)Draw a diagram showing this situation.(b)Now suppose that future income increases. Show what happens in your diagram. What happens to the world real interest rate and the equilibrium quantities of saving, investment, and the current account balance?(c)Repeat parts (a) and (b) for the case of a large open economy, showing a situation in which the home country initially has a current account surplus. Draw a diagram and describe how the rise in future income in the home country affects all four variables (the world real interest rate and the equilibrium quantities of saving, investment, and the current account balance) in both countries.

What will be an ideal response?

(b)The increase in future income shifts the desired saving curve to the left, so the new equilibrium 
quantity of saving declines, the equilibrium quantity of investment does not change, the current account balance declines, and the world real interest rate does not change.
(c)In a large open economy, the increase in future income in the home country shifts the desired 
saving curve to the left, which causes the world real interest rate to rise to restore equilibrium. In the home country, the equilibrium quantity of saving declines and the equilibrium quantity of investment declines. In the foreign country, the equilibrium quantity of saving rises, the equilibrium quantity of investment declines, so the current account balance increases (or the current account deficit declines). Since the current account balance increases in the foreign country, it decreases in the domestic country.

Economics

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If the size of the underground economy is large

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