PROBLEM SET 2

BALANCE OF PAYMENTS
Q 1. The demand for imports function is:
Q m=40−1 .5 Pm
Calculate the quantity of imports if the foreign price of imports is 10 and the exchange rate
(domestic/foreign) is 1.20. Also calculate the demand for foreign exchange at this rate.

Q 2. Using the same demand function as in problem 1, calculate the quantity of foreign
exchange demanded at the exchange rate of: 1.30, 1.40.

Q 3. Consider the situation of La Nación, a hypothetical Latin American country.

In 2014, La Nación was a net debtor to the rest of the world. Assume that all of La Nación’s foreign
debt was dollar denominated, and at the end of 200X, its net private foreign debt was $75 billion
and the official foreign debt of La Nación’s treasury was $55 billion.

Suppose that the interest rate on these debts was 2.5% per annum (p.a.) over the London Interbank
Offering Rate (LIBOR), and no principal payments were due in 20X1.

International reserves of the Banco de Nación, La Nación’s central bank, were equal to $18 billion at
the end of 200X and earn interest at LIBOR.

1
There were no other net foreign assets in the country. Because La Nación is growing very rapidly,
there is great demand for investment goods in La Nación.

Suppose that residents of La Nación would like to import $37 billion of goods during 20X1.
Economists indicate that the value of La Nación’s exports is forecast to be $29 billion of goods during
20X1. Suppose that the Banco de Nación is prepared to see its international reserves fall to $5 billion
during 20X1. The LIBOR rate for 20X1 is 4% p.a.

What is the minimum net capital inflow during 20X1 that La Nación must have if it wants to see the
desired imports and exports occur and wants to avoid having its international reserves fall below the
desired level?