Question

a. [5 marks] Draw 2 diagrams (1 of loanable funds market and the other of foreign exchange market) for a small open economy where the world real interest rate is higher than domestic real interest rate . Draw the initial equilibrium in both markets and label them completely.

b. [5 marks] On the same set of diagrams, show the effect of a decrease in national saving in both markets. Clearly show the new equilibrium in both markets with all the labels.

c. [5 marks] Explain what happens to the following with reasons for change in each.

i- real interest rate

ii- net capital outflow

iii- real exchange rate iv- net exports

Answer 1