Answer Happy

3. Effects of a government budget deficit Consider a hypothetical open economy. The following table presents data on the relationship between various real Interest rates and national saving, domestic investment, and net capital outflow in this economy, where the currency is the U.S. dollar. Assume that the economy is currently experiencing a balanced government budget. Real Interest Rate (Percent) 7 5 4 National Saving (Billions of dollars) 40 35 30 25 20 15 Domestic Investment (Billions of dollars) 25 30 35 40 45 50 Net Capital Outflow (Billions of dollars) -15 -10 -5 0 5 10 Given the information in the preceding table, use the blue points (circle symbol) to plot the demand for loanable funds. Next, use the orange points (square symbol) to plot the supply of loanable funds. Finally, use the black point (cross symbol) to indicate the equilibrium in this market.

REAL INTEREST RATE -20 Net Capital Outflow 10 5 -15 -10 5 10 NET CAPITAL OUTFLOW (Billions of dollars) 15 A 20 NCO + Eqm. NCO (?)

-20 -15 -10 50 5 10 NET CAPITAL OUTFLOW (Billions of dollars) 15 Because of the relationship between net capital outflow and net exports, the level of net capital outflow at the equilibrium real interest rate implie that the economy is experiencing a trade deficit 20 Now, suppose the government is experiencing a budget deficit. This means that national saving will decrease a decrease in the supply of loanable funds. Market for Foreign-Currency Exchange After the budget deficit occurs, suppose the new equilibrium real interest rate is 7%. The following graph shows the demand curve in the foreign- currency exchange market. 10 which leads to Use the green line (triangle symbol) to show the supply curve in this market before the budget deficit. Then use the purple line (diamond symbol) show the supply curve after the budget deficit.

REAL EXCHANGE RATE -20 -15 Market for Foreign-Currency Exchange 10 Demand -10 10 QUANTITY OF DOLLARS (Billions) 15 A Initial Supply Supply with Deficit ?