Question

Suppose that Jamaica is a small, open economy. A war breaks out abroad and, as a result, Jamaican firms become uncertain about the future and decide to delay some investment projects. 1) Explain what effect this event would have on the Jamaican economy. You do not need to draw the graph, but you do need to describe which curves move and in what direction. No points will be given for answers without an explanation. 2) How would the following variables change as a result of this event? Saving Investment The trade balance The interest rate The exchange rate

Answer 1

There is a small open economy and domestic companies have decided to postpone their investment which means domestic investment declines. This increases net capital outflow (S - I) and shifts the S - I curve rightwards.

Real exchange rate will depreciate as it can be seen in the figure where it is reduced from e1 to e2

The trade balance is improved because in net exports has increased

There is a decline in the national investment

National Saving has not changed

As a result of this event the rate of interest is likely to be decreased.