Consider a small open economy whose demand and domestic supply of capital relationships are R = 30 - (1/2)K and K = 7R,respectively (where K and R denote capital and its marginal product).Capital is perfectly mobile internationally,and the yield on capital (R)in the rest of the world is 6.
I: This country's GDP exceeds 900.
II: This country's GNP exceeds 800.
A) I is true; II is not.
B) II is true; I is not.
C) Both I and II are true.
D) Neither I nor II is true.

Question

Quizplus · Accepted Answer

The equilibrium yield on capital is R = 6. Using the supply equation K = 7R, we find K = 42. GDP is R * K = 6 * 42 = 252, which is less than 900. GNP includes net factor income from abroad, which is the difference between the world yield and domestic yield times the capital stock. Since capital is perfectly mobile, GNP is higher than GDP, but without specific values for net factor income, we can't definitively say it exceeds 800. However, given the context, II is more likely true than I.

Consider a Small Open Economy Whose Demand and Domestic Supply