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Consider an economy with an external debt of D=80. Assume the economy's capacity to honor its debt is state-dependent. Specifically, suppose there are two states: good and bad. In the good state the economy can pay its debt in full. In the bad state it can pay at most 20. The probability of the bad state is given by 7(D)= min {1,0.01D} a. Calculate the value of the economy's external debt on the secondary market. b. Would it be in creditors' collective best interest to forgive 10 units of debt? c. Calculate the maximum amount of debt forgiveness that would be in creditors' collective best interest.

Consider an economy with an external debt of D=80. Assume the economy's capacity to honor its debt is state-dependent. Specifically, suppose there are two states: good and bad. In the good state the economy can pay its debt in full. In the bad state it can pay at most 20. The probability of the bad state is given by 7(D)= min {1,0.01D} a. Calculate the value of the economy's external debt on the secondary market. b. Would it be in creditors' collective best interest to forgive 10 units of debt? c. Calculate the maximum amount of debt forgiveness that would be in creditors' collective best interest.

ENGR.ECONOMIC ANALYSIS
ENGR.ECONOMIC ANALYSIS
14th Edition
ISBN:9780190931919
Author:NEWNAN
Publisher:NEWNAN
Chapter1: Making Economics Decisions
Section: Chapter Questions
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Consider an economy with an external debt of D = 80. Assume the economy's capacity to honor its debt is state-dependent. Specifically, suppose there are two states: good and bad. In the good state the economy can pay its debt in full. In the bad state it can pay at most 20. The probability of the bad state is given by T(D) = min {1,0.01D} a. Calculate the value of the economy's external debt on the secondary market. b. Would it be in creditors' collective best interest to forgive 10 units of debt? c. Calculate the maximum amount of debt forgiveness that would be in creditors' collective best interest. d. Calculate the amount of debt forgiveness that maximizes creditors' collective welfare. e. Suppose now that D=50 and the IMF agrees to buy 10 units of the country's debt, which it will unilaterally forgive. i. What price (per unit) will the IMF have to pay to buy this debt on the secondary market? ii. What is the total cost of the operation? iii. By how much does creditors' expected income increase? iv. By how much does the debtor nation's expected payments decline?
Transcribed Image Text:Consider an economy with an external debt of D = 80. Assume the economy's capacity to honor its debt is state-dependent. Specifically, suppose there are two states: good and bad. In the good state the economy can pay its debt in full. In the bad state it can pay at most 20. The probability of the bad state is given by T(D) = min {1,0.01D} a. Calculate the value of the economy's external debt on the secondary market. b. Would it be in creditors' collective best interest to forgive 10 units of debt? c. Calculate the maximum amount of debt forgiveness that would be in creditors' collective best interest. d. Calculate the amount of debt forgiveness that maximizes creditors' collective welfare. e. Suppose now that D=50 and the IMF agrees to buy 10 units of the country's debt, which it will unilaterally forgive. i. What price (per unit) will the IMF have to pay to buy this debt on the secondary market? ii. What is the total cost of the operation? iii. By how much does creditors' expected income increase? iv. By how much does the debtor nation's expected payments decline?
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For question b, the new expected repayment is 35, which is 3 units more than the original expected repayment, 32. Isn't the answer Yes? It should be in the best interest.

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