The following table shows commodity prices in world markets. In the table,prices of oil are expressed in dollars per barrel, prices of wheat are expressed in dollars per bushel.
Price
Commodity Period 1 Period 2
Wheat 1 1
Oil 1 2
Kuwait is a two-period economy that produces oil and consumes wheat. Consumers have preferences described by the lifetime utility function
U(C1, C2) = ln C1 + ln C2,
where C1 and C2 denote consumption of wheat in periods 1 and 2, respectively, measured in bushels. Kuwait’s per-capita endowment of oil is 5 barrels in each period. Kuwait starts period 1 with net financial assets carried over from period 0
1
ECON 7520 SEMESTER 1, 2023
worth 1.1 bushels of wheat including interest at rate r0 = 0.1 (i.e., (1 + r0)B0 =
1.1). The country enjoys free capital mobility and the world interest rate r∗ between periods 1 and 2 is 10 percent. Financial assets are denominated in units of wheat.
(a) What are the terms of trade faced by Kuwait in periods 1 and 2?
(b) Calculate consumption, the trade balance, the current account and national savings in periods 1 and 2.