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Lecture 22.docx

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Hannah Holmes

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Lecture 22 The market for loanable funds Savings is determined by the intersection of rw and supply curve Investment is determined by the intersection of rw and demand curve NCO = S – I, which means the horizontal distance between and supply curve and demand curve at rw. The market for foreign-currency exchange NCO = quantity supplied by quantity demanded at rw. If that equals 50 billion dollars, then that supply curve is at 50 billion dollars. If Net Export changes, the demand curve is going to shift. The real exchange rate is the vertical axis variable, it is determined by the intersection point of the supply and demand curves. Case 1: Effects of an increase in the world interest rate - The top diagram is affected - The rw curve is involved - There is an effect to the bottom diagram (The supply curve is going to shift, because NCO = S). The supply will be shifted to the right due to a higher NCO from first diagram - Interest rate is increased. We can see by looking at the rw2 in the loanable funds diagram - Investment is decreased. I2 is smaller than I1 - National saving is increased. S2 is bigger than S1 - Private saving is increased because the interest rate goes up. When it goes up every dollar I saved today get me more dollars I can spend in the future on consumption goods. That makes people want to save more. - Public saving is not changed (taxes – government spending). There is no relationship between public savings and interest rates. - NCO goes up. NCO2 is bigger than NCO1 in both diagrams - Net exports goes up because NCO is equal to NX NCO = S – I Since savings is bigger than investment, NCO is bigger Top Diagram Bottom Diagram NCO being bigger means domestic residences are purchasing more foreign assets than foreign residences are purchasing domestic assets. In order for us to buy this new increase in foreign assets, we need to buy foreign currency and we are using Canadian dollars to pay for that foreign currency. So we have an increase in our supply in Canadian dollars, in the market of foreign currency exchan
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