# Pakistan’s GDP is \$230 billion per year, and Pakistan’s interest rate is constant at 10%. In year 1 Pakistan is hit by a strong earthquake which…

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Pakistan’s GDP is \$230 billion per year, and Pakistan’s interest rate is constant at 10%. In year 1 Pakistan is hit by a strong earthquake which causes its GDP to drop this year to only \$120 billion. Income will recover back to \$230 billion in all subsequent years. Assume Pakistan consumers aim to perfectly smooth consumption across all future years, and are able to borrow at an interest rate of 10% from foreigners.

a) (3 points) What will the path of Pakistan’s Consumption(C) in the year of the earthquake and subsequent years. Complete the corresponding row of the table.

(b) (3 points) What will the path of Pakistan’s Trade Balance(TB) in the year of the earthquake and subsequent years. Complete the corresponding row of the table.

(c) (3 points) What will the path of Pakistan’s Net Factor Income from Abroad(NFIA) in the year of the earthquake and subsequent years. Complete the corresponding row of the table.

(d) (3 points) What will the path of Pakistan’s Financial Account(FA) in the year of the earthquake and subsequent years. Complete the corresponding row of the table.

(e) (3 points) In the year after the earthquake(year 2) Pakistan discovers massive shale gas deposits offshore. Accessing the shale gas will require an investment of \$15 billion. If exploited, on current projections of gas prices, the gas deposits could yield an income of \$2 billion a year indefinitely, beginning in the year following the investment. Would it be profitable for Pakistani firms to invest in developing the gas fields? Explain Why

a) At 10% interest rate,Investment 0.1 X 230 = 23 millionIn equilibrium Investment = SavingsConsumption = GDP ­ Savings= \$207billionb) Trade balance will be = GDP ­ Consumption extra…

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