ABSTRACT
By the beginning of this chapter, both government sectors know the amount of public goods they will produce next period, but they still must decide the optimal combination of inputs to use in producing those goods. These decisions rest upon current interest rates and exchange rates, which were not yet known when the respective household sectors selected next period’s production of public goods. By the beginning of this chapter, the non-financial business sectors in each country have also announced current period wages and prices and decided current output and employment. But, they have yet to decide their scales of plant with which to begin next period, in particular, their end-of-current period levels of physical capital, the number of people they will employ by the end of the current period, the volume of intermediate goods they will order this period from the other country for delivery and use next period, and their end-of-period stocks of their respective non-renewable resources. These decisions too depend upon current interest rates and exchange rates. The analysis contained in this chapter provides the foundation not only for the non-financial business sectors’ participation in the financial markets, but also for their demand for both domestic and foreign goods. The household sectors’ decisions analyzed in Chapter 2 in connection with their selection of next period’s production of public goods must also be updated now that current wages, prices and disposable incomes are known. In short, the analysis contained in the present chapter, coupled with the analysis of Chapter 4 lays the foundation for the simultaneous determination of current period interest rates, exchange rates, current spending by each sector, and the end-of-period scales of plant by both private and public producers in both countries. The demand and supply functions of the individual sectors derived in Chapters 4 and 5 will be combined in Chapters 6–8 to form markets for checkable deposits, bonds, non-interest bearing money and spot and forward contracts.
