Assignment #1
1 a)
The capital account of Country A will increase by 10 million in year 1 since that is the amount of overseas investment it takes to develop the mine. The capital account is essentially capital inflow – capital outflow. Since Country A does not have any inward or outward foreign direct investment prior to this event, it is safe to assume that the capital account will increase by 10 million in year 1.
In addition, in year 1, the trade account decrease by 10 million since 10 million dollars worth of equipment is shipped from overseas. In other words, the trade account which is X – M, will decrease by year 1’s import value. Lastly, the service account will remain unchanged and hence have no effect on the current account.
In year 2, the trade account will increase by 2 million since Country A will export all of its gold produced to overseas.
1 b)
As a result of the discovery of the mine, Country A’s imports will rise by 10 million dollars in year 1 due to the imported equipment costs of developing the mine. Furthermore, in year 1, Country A’s savings will remain the same while the value of their investment increases by 10 million. In year 1, the value of the current account decreases from the surge of imports. Hence according to the equation that states current account + capital account = change in federal reserves, Country A would have to decrease their federal reserve by the current account’s deficit.
However, as the goldmine starts its production and Country A begins to export more than it used to, Country A’s imports will fall in order to balance out the increase in exports. Therefore, the value of the current account increases as exports increase and imports decrease. Looking at the equation, Current Account = Sp – (G – T) – I, with the knowledge that the value of the current account has increased and that the variables G, T and I do not