Question

Joseph shulunga Name: Chapter 19 How Policies and Events Affect an Open Economy Please use the three-step process developed in Chapter 4. First, determine which of the curves have been affected. Second, determine in which direction the curves shift, and finally, use the diagrams to examine how these shifts alter equilibrium in the two markets. A. Government Budget Deficits 1. What will happen to supply of LF? 2. Real Interest rate? 3. Real exchange rate?

Answer 1

1.

As the government faces budget deficit, national savings get reduced, leading to a fall in supply of loanable funds. As a result of this, supply curve of loanable funds shifts to the left, leading to an increase in real interest rates and fall in quantity of funds in the market.

2.

As a result of the leftward shift of the supply curve of LF, there is an increase in the real interest rate

3.

An increase in interest rates makes investment in home country attractive. As a result, foreign investment increases, thereby increasing the demand for home country currency, leading to an increase in the real exchange rate.