ECON 214 HW19 Open Economy Theory Assignment solutions complete answers

ECON 214 HW19 Open Economy Theory Assignment solutions complete answers

 

1. Introduction to the loanable funds market

What is one of the reasons the demand curve for loanable funds is downward sloping in a large open economy?

 A lower real interest rate discourages investment.

 A higher real interest rate encourages people to save.

 A higher real interest rate makes borrowing more expensive.

 A lower real interest rate discourages domestic consumers from buying foreign assets and encourages foreigners to buy domestic assets.

 

What is the source of demand for loanable funds in a large open economy?

 Net foreign investment

 National saving and investment

 Net foreign investment and investment

 Investment

 

Why is the supply curve for loanable funds upward sloping in a large open economy?

 A higher real interest rate discourages domestic consumers from buying foreign assets.

 A higher real interest rate encourages people to save.

 A lower real interest rate encourages people to save.

 A lower interest rate makes borrowing more expensive.

 

2. Introduction to the foreign-currency exchange market

What is the source of supply of dollars in the foreign-currency exchange market in an open economy?

 Exports

 Investment and net capital outflow

 Net exports

 Net capital outflow

 

Why is the supply curve for dollars in the foreign-currency exchange market vertical in an open economy?

 Net capital outflow is determined by the real interest rate, not the real exchange rate.

 Net capital outflow is extremely sensitive to small changes in the real exchange rate.

 Net capital outflow equals net exports.

 Net capital outflow is determined by real GDP, not the real exchange rate.

 

What is the source of demand for dollars in the foreign-currency exchange market in an open economy?

 Imports

 Net capital outflow

 Net exports

 National saving

 

3. Effects of a government budget deficit

Suppose a hypothetical open economy uses the U.S. dollar as currency. The table below presents data describing the relationship between different real interest rates and this economy’s levels of national saving, domestic investment, and net capital outflow. Assume that the economy is currently operating under a balanced government budget.

Real Interest Rate
National Saving
Domestic Investment
Net Capital Outflow
(Percent)
(Billions of dollars)
(Billions of dollars)
(Billions of dollars)
7
40
25
-15
6
35
30
-10
5
30
35
-5
4
25
40
0
3
20
45
5
2
15
50
10
Given the information in the table above, use the blue points (circle symbol) to plot the demand for loanable funds. Next, use the orange points (square symbol) to plot the supply of loanable funds. Finally, use the black point (cross symbol) to indicate the equilibrium in this market.

 

On the following graph, plot the relationship between the real interest rate and net capital outflow by using the green points (triangle symbol) to plot the points from the initial data table. Then use the black point (X symbol) to indicate the level of net capital outflow at the equilibrium real interest rate you derived in the previous graph.

 

Because of the relationship between net capital outflow and net exports, the level of net capital outflow at the equilibrium real interest rate implies that the economy is experiencing    .

Now, suppose the government is experiencing a budget deficit. This means that    , which leads to    loanable funds.

After the budget deficit occurs, suppose the new equilibrium real interest rate is 7%. The following graph shows the demand curve in the foreign-currency exchange market.

Use the green line (triangle symbol) to show the supply curve in this market before the budget deficit. Then use the purple line (diamond symbol) to show the supply curve after the budget deficit.

 

Summarize the effects of a budget deficit by filling in the following table.

 
Real Interest Rate
Real Exchange Rate
Trade Balance
Effects of a Budget Deficit
    
    
    
 

3. Effects of a government budget deficit

Suppose a hypothetical open economy uses the U.S. dollar as currency. The table below presents data describing the relationship between different real interest rates and this economy’s levels of national saving, domestic investment, and net capital outflow. Assume that the economy is currently operating under a balanced government budget.

Real Interest Rate
National Saving
Domestic Investment
Net Capital Outflow
(Percent)
(Billions of dollars)
(Billions of dollars)
(Billions of dollars)
7
55
25
-10
6
50
35
-5
5
45
45
0
4
40
55
5
3
35
65
10
2
30
75
15
Given the information in the table above, use the blue points (circle symbol) to plot the demand for loanable funds. Next, use the orange points (square symbol) to plot the supply of loanable funds. Finally, use the black point (cross symbol) to indicate the equilibrium in this market.

 

On the following graph, plot the relationship between the real interest rate and net capital outflow by using the green points (triangle symbol) to plot the points from the initial data table. Then use the black point (X symbol) to indicate the level of net capital outflow at the equilibrium real interest rate you derived in the previous graph.

 

Because of the relationship between net capital outflow and net exports, the level of net capital outflow at the equilibrium real interest rate implies that the economy is experiencing    .

Now, suppose the government is experiencing a budget deficit. This means that    , which leads to    loanable funds.

After the budget deficit occurs, suppose the new equilibrium real interest rate is 7%. The following graph shows the demand curve in the foreign-currency exchange market.

Use the green line (triangle symbol) to show the supply curve in this market before the budget deficit. Then use the purple line (diamond symbol) to show the supply curve after the budget deficit.

 

Suppose a hypothetical open economy uses the U.S. dollar as currency. The table below presents data describing the relationship between different real interest rates and this economy’s levels of national saving, domestic investment, and net capital outflow. Assume that the economy is currently operating under a balanced government budget.

Real Interest Rate
National Saving
Domestic Investment
Net Capital Outflow
(Percent)
(Billions of dollars)
(Billions of dollars)
(Billions of dollars)
7
45
30
-15
6
40
35
-10
5
35
40
-5
4
30
45
0
3
25
50
5
2
20
55
10
Given the information in the table above, use the blue points (circle symbol) to plot the demand for loanable funds. Next, use the orange points (square symbol) to plot the supply of loanable funds. Finally, use the black point (cross symbol) to indicate the equilibrium in this market.

 

On the following graph, plot the relationship between the real interest rate and net capital outflow by using the green points (triangle symbol) to plot the points from the initial data table. Then use the black point (X symbol) to indicate the level of net capital outflow at the equilibrium real interest rate you derived in the previous graph.

 

Because of the relationship between net capital outflow and net exports, the level of net capital outflow at the equilibrium real interest rate implies that the economy is experiencing    .

Now, suppose the government is experiencing a budget deficit. This means that    , which leads to    loanable funds.

After the budget deficit occurs, suppose the new equilibrium real interest rate is 6%. The following graph shows the demand curve in the foreign-currency exchange market.

Use the green line (triangle symbol) to show the supply curve in this market before the budget deficit. Then use the purple line (diamond symbol) to show the supply curve after the budget deficit.

 

4. Analyzing the effects of a trade deficit

Suppose the U.S. government has just hired you to analyze the following scenario. Assume the U.S. agricultural industry grows concerned about the amount of fresh fruit imports to the United States, a practice that harms domestic producers. Industry experts claim that implementing a tariff on imports would reduce the size of the trade deficit. Complete the following exercise in order to help you analyze this claim.

The following graph shows the demand and supply of U.S. dollars in a model of the foreign-currency exchange market.

Shift the demand curve, the supply curve, or both to show what would happen if the government decided to implement the tariff.

 

Given this change, the dollar    .

Fill in the following table with the effect of a tariff on the following items:

 
Demand for Loanable Funds
Real Interest Rate
National Saving
Net Exports
Change due to a tariff
    
    
    
    
 

Suppose the U.S. government has just hired you to analyze the following scenario. Assume the U.S. automobile industry grows concerned about foreign manufacturers exporting fuel-efficient vehicles to the United States, a practice that harms domestic producers. Industry experts claim that implementing a quota on imports would reduce the size of the trade deficit. Complete the following exercise in order to help you analyze this claim.

The following graph shows the demand and supply of U.S. dollars in a model of the foreign-currency exchange market.

Shift the demand curve, the supply curve, or both to show what would happen if the government decided to implement the quota.

 

Given this change, the dollar    .

Fill in the following table with the effect of a quota on the following items:

 
Supply of Loanable Funds
Real Interest Rate
Domestic Investment
Net Exports
Change due to a quota
    
    
    
    
 

Suppose the U.S. government has just hired you to analyze the following scenario. Assume the U.S. manufacturing industry grows concerned about competition from low-cost producers overseas exporting their goods to the United States, a practice that harms domestic producers. Industry experts claim that implementing a quota on imports would reduce the size of the trade deficit. Complete the following exercise in order to help you analyze this claim.

The following graph shows the demand and supply of U.S. dollars in a model of the foreign-currency exchange market.

Shift the demand curve, the supply curve, or both to show what would happen if the government decided to implement the quota.

 

Given this change, the dollar    .

Fill in the following table with the effect of a quota on the following items:

 
Demand for Loanable Funds
Real Interest Rate
Net Capital Outflow
Net Exports
Change due to a quota
    
    
    
    
 

5. Capital flight

The graphs below depict the loanable funds market and the relationship between real interest rates and the level of net capital outflow (NCO) calculated in terms of the Mexican peso.

 

Complete the first row of the table to reflect the state of the markets in Mexico.

 
Real Interest Rate
Net Capital Outflow (NCO)
(Percent)
(Billions of pesos)
Initial state
 
 
After capital flight
 
 
Suppose now that a sudden bout of political turmoil in Mexico causes world financial markets to become uneasy. Because investors now see Mexico as unstable, they decide to pull a portion of their assets out of Mexico and put them into more stable economies. This unexpected shock to the demand for assets in Mexico is known as capital flight.

Shift the NCO curve to illustrate the effect of capital flight. Then, on the graph representing the market for loanable funds, shift the supply curve, the demand curve, or both curves to reflect the change caused by the shift in NCO.

Note: You will not be graded on your final placement of the curves on the graph, but you will need to shift them correctly in order to answer the questions that follow.

Determine the equilibrium interest rate after capital flight occurs, and enter it into the second row of the table. Then determine the level of NCO that occurs along the new NCO curve at the new equilibrium interest rate.

Finally, show the effect of the change in NCO on the market for foreign exchange by shifting either the supply curve, the demand curve, or both.

 

Summarize the results of capital flight by completing the following table.

 
Real Interest Rate
Real Exchange Rate
Net Capital Outflow
Effects of capital flight
    
    
    
 

The graphs below depict the loanable funds market and the relationship between real interest rates and the level of net capital outflow (NCO) calculated in terms of the Mexican peso.

 

Complete the first row of the table to reflect the state of the markets in Mexico.

 
Real Interest Rate
Net Capital Outflow (NCO)
(Percent)
(Billions of pesos)
Initial state
 
 
After capital flight
 
 
Suppose now that a sudden bout of political turmoil in Mexico causes world financial markets to become uneasy. Because investors now see Mexico as unstable, they decide to pull a portion of their assets out of Mexico and put them into more stable economies. This unexpected shock to the demand for assets in Mexico is known as capital flight.

Shift the NCO curve to illustrate the effect of capital flight. Then, on the graph representing the market for loanable funds, shift the supply curve, the demand curve, or both curves to reflect the change caused by the shift in NCO.

Note: You will not be graded on your final placement of the curves on the graph, but you will need to shift them correctly in order to answer the questions that follow.

Determine the equilibrium interest rate after capital flight occurs, and enter it into the second row of the table. Then determine the level of NCO that occurs along the new NCO curve at the new equilibrium interest rate.

Finally, show the effect of the change in NCO on the market for foreign exchange by shifting either the supply curve, the demand curve, or both.

 

Summarize the results of capital flight by completing the following table.

 
Real Interest Rate
Real Exchange Rate
Net Capital Outflow
Effects of capital flight
    
    
    
 

The graphs below depict the loanable funds market and the relationship between real interest rates and the level of net capital outflow (NCO) calculated in terms of the Mexican peso.

 

Complete the first row of the table to reflect the state of the markets in Mexico.

 
Real Interest Rate
Net Capital Outflow (NCO)
(Percent)
(Billions of pesos)
Initial state
 
 
After capital flight
 
 
Suppose now that a sudden bout of political turmoil in Mexico causes world financial markets to become uneasy. Because investors now see Mexico as unstable, they decide to pull a portion of their assets out of Mexico and put them into more stable economies. This unexpected shock to the demand for assets in Mexico is known as capital flight.

Shift the NCO curve to illustrate the effect of capital flight. Then, on the graph representing the market for loanable funds, shift the supply curve, the demand curve, or both curves to reflect the change caused by the shift in NCO.

Note: You will not be graded on your final placement of the curves on the graph, but you will need to shift them correctly in order to answer the questions that follow.

Determine the equilibrium interest rate after capital flight occurs, and enter it into the second row of the table. Then determine the level of NCO that occurs along the new NCO curve at the new equilibrium interest rate.

Finally, show the effect of the change in NCO on the market for foreign exchange by shifting either the supply curve, the demand curve, or both.

 

Summarize the results of capital flight by completing the following table.

 
Real Interest Rate
Real Exchange Rate
Net Capital Outflow
Effects of capital flight