Question

With the aid of a diagram, comment on the effect of an increase in the government budget surplus (or a decrease in the government budget deficit) on the real interest rate, desired saving, and net exports for a – i. Large open economy ii. Small open economy.................pls let the solution be type out. thks

Answer 1

With the fall in the budget deficit, the level of public savings in the economy rises and thus supply curve of loanable funds will shift rightwards and thus rate of interest will decline in the loanable fund market. This decline in the rate of interest will lead to capital outflow and thus currency depreciates in the small open economy and this leads to increase in net exports of the small open economy. However, in case of large open economy the capital ouflow will be small and thus currency depreciates by a smaller amount and thus increase in net exports is comparatively smaller.