Consider a two-period small open endowment economy populated by a large number of house-holds with preferences described by the lifetime utility function
where C1 and C2 denote, respectively, consumption in periods 1 and 2.Suppose that householdsreceive exogenous endowments of goods given by Q1 = Q2 = 10 in periods 1 and 2, respectively.Every household enters period 1 with some debt, denoted B∗
0 , inherited from the past.Let B∗
be equal to −5.The interest rate on these liabilities, denoted r0, is 20 percent.Finally, supposethat the country enjoys free capital mobility and that the world interest rate on assets heldbetween periods 1 and 2, denoted r∗, is 10 percent.
(a) Compute the equilibrium levels of consumption, the trade balance, and the currentaccount in periods 1 and 2.