An emerging economy as a current GDP of $100 billion. It borrows $20 billion at a real interest rate of 5%, which it will repay next year. The costs of default are 25% of GDP. At the GDP level of $110 billion, what will be the country's consumption if it repays the loan?

Question

Quizplus · Accepted Answer

The country's consumption after repaying the loan can be calculated as follows: The initial GDP is $100 billion, and it borrows $20 billion, making the total available $120 billion. The real interest rate is 5%, so the repayment amount is $20 billion * 105% = $21 billion. If the GDP grows to $110 billion and the country repays the loan, the available amount for consumption is $110 billion (new GDP) - $21 billion (repayment) = $89 billion.

An Emerging Economy as a Current GDP of $100 Billion