ECO 1102 Lecture Notes - Lecture 15: Loanable Funds, Real Interest Rate, Autarky

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30 Mar 2016

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ECO 1102 Full Course Notes

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A macroeconomic theory of the small open economy. The goal of the model in this chapter is. To highlight the forces that determine the economy"s trade balance and exchange rate. To understand what factors determine a country"s trade balance and how government policies can afect it, we need a small open economy. Assumpions for our small open economy model: the level of gdp is a given, the price level is ixed, the real interest rate is equal to the world interest rate is taken as given. The focus is on supply and demand on two markets to understand the forces at work in an open economy: Recall that in a small open economy with perfect capital mobility, the domesic interest rate will equal the world interest rate. The market for loanable funds in a small open economy with perfect capital mobility is diferent from that in a closed economy.

Related Questions

Many people believe that Congress will eventually have to reduceSocial Security benefits in order to reduce the budget deficit.Although most of the changes would not take place until later,assume for the purpose of this problem that Social Securitybenefits were cut today by $100billion per year.
A) If the marginal propensity to consume is 0.8, explain what thelong-run effects would be on real GDP, public saving, and nationalsaving.
B) The US is a large open economy with a trade deficit. Use theappropriate graphs to illustrate and state what the reduction inSocial Security benefits would do to each of the following inthelong run: national saving, investment, the US real interest rate,net capital outflows, the real exchange rate, and the tradedeficit.
C) Now, consider the small open economy of Norway, which has atrade surplus. If the US, a large open economy, were to reduce itsSocial Security benefits, use the appropriate graphs to illustrateand state what would happen in the long run to Norwayâs nationalsaving, investment, interest rate, real exchange rate, and tradesurplus.

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5. Saving and net flows of capital and goods In a closed economy, saving and investment must be equal, but this is not the case in an open economy. In the following problem, you will explore how saving and investment are connected to the international flow of capital and goods in an economy. Before delving into the relationship between these various components of an economy, you will be asked to recall some relationships between aggregate variables that will be useful in your analysis. Recall the components that make up GDP. National income (Y) equals total expenditure on the economy's output of goods and services. Thus, where C = consumption, I = investment, G = government purchases, X = exports, M = imports, and NX = net exports: Y = Also, national saving is the income of the nation that is left after paying for . Therefore, national saving (S) is defined as: S = Rearranging the previous equation and solving for Y yields Y = . Plugging this into the original equation showing the various components of GDP results in the following relationship: S = This is equivalent to S = , since net exports must equal net capital outflow (NCO, also known as net foreign investment). Now suppose that a country is experiencing balanced trade. Determine the relationships between the entries in the following table, and enter these relationships using the following symbols: > (greater than), < (less than), or = (equal to). Outcomes of Balanced Trade Imports Exports 0 Net Exports Y C+I+G Investment Saving Net Capital Outflow 0

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True or False

1. The loanable fund market demand is the demand for consumption.

( ) 2. An increase in the bond price increases the bond yield.

( ) 3. An increase in the stock price increases the stock rate of return.

( ) 4. Monopoly increases unemployment, but monopsony does not.

( ) 5. The open market operation is the changes in interest rate in open market.

( ) 6. The high reserve requirement has the direct relationship with money creation.

( ) 7. The money value and price level have inverse relationship.

( ) 8. The nominal interest rate is related to inflation.

( ) 9. An inflation tax is the tax put on inflation.

( ) 10. Government expenditure belongs to the aggregate supply.

( ) 11. 1973-1975 recession is due to aggregate demand shift.

( ) 12. 2001 recession is due to aggregate demand shift.

( ) 13. As potential GDP is smaller than actual GDP, recession occurs.

( ) 14. A money supply results in shift of aggregate supply GDP.

( ) 15. The multiplier effect is bigger as marginal propensity to consume is smaller.

( ) 16. The multiplier effect comes together with crowding effect.

( ) 17. A recession results in decrease of welfare program.

( ) 18. A recession results in decrease of tax revenue.

( ) 19. The unemployment and inflation are in inverse relation.

( ) 20. The unemployment and inflation relation does not related to aggregate demand.

( ) 21. A quota deceases export

( ) 22. A tariff decreases import.

( ) 23. A real exchange rate is not related to nominal exchange rate.

( ) 24. A purchasing power parity exchange rate is not related to nominal exchange rate.

( ) 25. A flexible exchange rate is not related to nominal exchange rate.

( ) 26. The export increases consumer surplus.

( ) 27. The trade deficit results in capital inflow.

2. Summarize

(1) loanable fund market

(2) monetary policy tools

(3) quantity equation

(4) Okun's law

(5) mutiplier effect and crowding effect

(6) automatic stabilizers

(7) risk aversion and risk taking

(8) Fisher effect

(9) aggregate model

(10) aggregate demand shift

(11) Phillips curve

(12) protectionist policies

(13) capital inflow and capital outflow

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ECO 1102 Lecture Notes - Lecture 15: Loanable Funds, Real Interest Rate, Autarky

ECO 1102 Full Course Notes

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