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ECON 7520 SEMESTER 2, 2023
Problem Set
This is an open book assignment. No generative AI such as ChatGPT permitted.
This is an individual assignment — group work is not permitted.
You have until 10.00h AEST on September 8, 2023 to 1) download and 2) work
on the assignment and to 3) upload your answers. You are required to upload your
answers as a single, legible pdf file to the relevant Blackboard assignment link.
E.g., you can handwrite your answers and then convert them to a pdf file.
Please keep your pdf file reasonably small (say ≤ 5MB).
You may email your pdf file to c.mueller@uq.edu.au as proof of your time
of submission if you experience technical difficulties with uploading it. You then
still have to upload the same pdf file to Blackboard as soon as possible.
File formats other than pdf are not permitted. You may not submit multiple files.
Where an extension has not been approved, the following penalties apply to late or
non-submission: A penalty of 10% of the maximum possible mark of the problem
set will be deducted per day for up to 7 calendar days, at which point any submis_xfffe_sion will not receive any marks unless an extension has been approved. Each 24
hour block is recorded from the time the submission is due.
By undertaking this assignment you will be deemed to have made the following
declaration: “I certify that
– my submission is entirely my own original work, and no part of my answers
has been copied from any other source or person except where due acknowl edgement is made,
– no part of the work has been previously submitted for assessment in this or
any other institution,
– I have neither given nor received any unauthorized assistance on this assess ment item, and
– I am familiar with and understand the implications of UQ’s policies relating
to academic integrity and student conduct.”
Instructions: Answer all questions. Show all your work — you must explain how you
arrived at your answer. Partial credit may be awarded if a substantial part of the answer
is provided.
Total Questions: 4
Total Marks: 50
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ECON 7520 SEMESTER 2, 2023
Answer all questions.
Show all your work — you must explain how you arrived at your answer.
Partial credit may be awarded if a substantial part of the answer is provided.
Question 1 (5 marks)
Download the external wealth of nations database1
from
https://www.brookings.edu/articles/
the-external-wealth-of-nations-database/
For each of Australia and the US, in millions of USD:
(a) (2 marks) Sum the current account balances from 1971 to the latest date available.
(Hint: You can do this in Excel and report the results here.)
(b) (2 marks) Find the change in the NIIP (“Net IIP excl gold”) over the corresponding
period.
(c) (1 mark) Compute the cumulative valuation change over the same corresponding pe riod.
Question 2 (6 marks)
The international asset and liability positions of countries 1, 2 and 3 are as follows:
Country 1:
– International Asset Position (A1
): $50 in shares of firms residing in country
2, and $50 in shares of firms residing in country 3.
– International Liability Position (L
1
): $200 in bonds issued by country 1 and
held by foreign residents.
Country 2:
– International Asset Position (A2
): $100 in bonds issued by the government of
country 1.
– International Liability Position (L
2
): $75 in shares of firms residing in coun try 2 and held by foreign residents.
Country 3:
1Milesi-Ferretti, Gian Maria, 2022, “The External Wealth of Nations Database,” The Brookings Insti tution (based on Lane, Philip R. and Gian Maria Milesi-Ferretti, 2018, “The External Wealth of Nations
Revisited: International Financial Integration in the Aftermath of the Global Financial Crisis,” IMF Eco nomic Review 66, 189-222)
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ECON 7520 SEMESTER 2, 2023
– International Asset Position (A3
): $100 in bonds issued by the government of
country 1, and $25 in shares of firms residing in country 2.
– International Liability Position (L
3
): $50 in shares of firms residing in coun try 3 and held by foreign residents..
Suppose that the rate of return of bonds issued by the government of country 1 is
r
1 = 1 percent, that the rate of return on shares of firms residing in country 2 is r
2 = 2
percent, and that the rate of return on shares of firms residing in country 3 is r
3 = 3
percent.
(a) (1.5 marks) For each country i = 1, 2, 3, calculate the net international investment
position N IIPi
.
(b) (1.5 marks) For each country i = 1, 2, 3, calculate the net investment income N IIi
.
(c) (1.5 marks) Suppose that an analyst only observes the pairs (N IIPi
, N IIi
) for i =
1, 2, 3. What would she most likely find paradoxical about them Knowing all of the
data, how would you explain those apparent paradoxes
(d) (1.5 marks) Take the country with strictly negative N IIP and strictly positive N II.
What would a believer in dark matter say is the true NIIP, denoted TNIIP What
would she say dark matter amounts to Suppose that in her calculations, this analyst
uses the average rate of return across all securities, that is, r =
1
3
(r
1 + r
2 + r
3
).
Question 3 (27 marks)
Consider a single-good, two-period small open endowment economy populated by a
representative household with preferences described by the lifetime utility function
ln C1 + ln C2,
where C1 and C2 denote consumption in periods 1 and 2, respectively. The household
receives exogenous endowments of the good of Q1 = 8 and Q2 = 4 in periods 1 and
2, respectively, and carries over B0 = 50 units of a bond from “period 0” into period 1.
The interest rate paid on those bonds in period 1 is r0 = 0.01. The country enjoys free
capital mobility and the world interest rate r
on assets held between periods 1 and 2 is
25 percent.
(a) (3 marks) Derive the household’s intertemporal budget constraint.
(b) (12 marks) State the equilibrium conditions for this economy and derive from them
the equilibrium levels in periods 1 and 2 of consumption, the trade balance, and the
current account.
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ECON 7520 SEMESTER 2, 2023
(c) (7 marks) Draw into a figure with period-1 consumption on the horizontal axis and
period-2 consumption on the vertical axis the household’s intertemporal budget con straint, the endowment path (Q1, Q2), the optimal consumption path and the indif ference curve that contains the optimal consumption path. Indicate the period-1 trade
balance T B1 in your figure.
Explain why or why not the endowment path lies on the household’s intertemporal
budget constraint.
(d) (5 marks) Suppose that at the beginning of period 1, the household unexpectedly
learns that the initial interest rate r0 increases to 0.2. Calculate by how many units of
the consumption good
the household is richer in period 1
the trade balance in period 1 improves or deteriorates
the current account balance in period 1 improves or deteriorates
due to this interest rate shock. Provide intuition for your results.
Question 4 (12 marks)
Consider the model discussed in the “Import Tariffs” part of our Lecture 4 slides
(pages 17-23 of Slides 04.pdf). In particular, consider a two-period, two-good economy
which exports endowments (Q1, Q2) of oil and imports food for consumption (C1, C2).
The household is populated by a representative household. Assume that the utility func tion of the representative household is given by
U(C1, C2) = ln C1 + ln C2.
In each period t = 1, 2, the government imposes an import tariff τt ≥ 0 and returns to the
household the revenue from this tariff via a lump-sum transfer Lt within the same period.
Let x ≡
1+τ1
1+τ2
.
(a) (4 marks) Assume that the household treats Lt
, t = 1, 2, as exogenously given.
Derive the equilibrium values of consumption in periods 1 and 2 as functions of x,
r0, r

, B0, Q1, Q2, T T1 and T T2.
(b) (5 marks) Continue to assume that the household treats Lt
, t = 1, 2, as exogenously
given. Plug the equilibrium values of C1 and C2 into the utility function. Then find
the value of x that maximizes the household’s welfare. Interpret your result.
(c) (3 marks) Now assume that the household does not treat Lt
, t = 1, 2, as exogenously
given. Instead, the household takes into account that if the household pays more im port tariff in a period, then the lump-sum transfer in that period increases accordingly.
Suppose that x = 1.5. Write down the household’s intertemporal budget constraint
and derive its slope. Argue whether removing the import tariffs τt for t = 1, 2 would
improve the household’s welfare in this case.
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