Consider a small open economy that takes the world real interest rate as given. Suppose the world real interest rate is less than the country’s autarky real interest rate. Which of the following is TRUE? Group of answer choices None of the other options There is excess demand for capital Domestic saving exceeds domestic investment There is capital outflow
Question
Consider a small open economy that takes the world real interest rate as given. Suppose the world real interest rate is less than the country’s autarky real interest rate. Which of the following is TRUE?
Group of answer choices
None of the other options
There is excess demand for capital
Domestic saving exceeds domestic investment
There is capital outflow
Solution
In a small open economy that takes the world real interest rate as given, if the world real interest rate is less than the country’s autarky real interest rate, it means that the cost of borrowing capital from the world market is cheaper than the cost of using domestic capital.
This situation will lead to an excess demand for capital because firms will want to borrow more at the lower interest rate to invest in their businesses.
However, this does not necessarily mean that domestic saving exceeds domestic investment. In fact, it could be the opposite. If the domestic interest rate is higher than the world interest rate, it could mean that there is not enough domestic saving to meet the demand for investment, hence the need to borrow from the world market.
Finally, this situation will lead to capital outflow. Since the world interest rate is lower, domestic investors will want to lend their capital to the world market where they can earn a higher return. This will result in a net outflow of capital from the country.
So, the correct answer is: "There is excess demand for capital" and "There is capital outflow".
Similar Questions
Consider a small open economy that takes the world real interest rate as given. Suppose that initially the world real interest rate is less than the country’s autarky real interest rate. Now suppose there is a change in tax policy that leads to an increase in domestic investment demand. Which of the following is TRUE?Group of answer choicesThe economy may flip from importing capital to exporting capitalThere is an increase in the quantity of domestic savingThere is an increase in the real interest rate paid by domestic investorsNone of the other options
Consider a small open economy that does not permit international borrowing or lending. The country’s autarky real interest rate is greater than the world real interest rate. Suppose the country removes its capital controls. Which of the following is TRUE?Group of answer choicesThere is an excess demand for capital in the domestic economy and capital flows inThere is an excess demand for capital in the domestic economy and capital flows outThere is an excess supply of capital in the domestic economy and capital flows inThere is an excess supply of capital in the domestic economy and capital flows out
In an open economy with a given level of real interest rates and risk, a decrease in real interest rates abroad will _____ capital inflows and _____ the equilibrium domestic real interest rate.Group of answer choicesincrease; increasedecrease; increaseincrease; not changeincrease; decrease
What impact will the increase in investment demand have on the real interest rate of the small open economy? Briefly explain your answer. (2 marks)
Consider the classical model of a small open economy with perfect capital mobility. Suppose domestic political stability improves and optimism about future conditions increases, causing firms to raise their investment sharply.Based on the above information, answer the following questions.What impact will the increase in investment demand have on the real interest rate of the small open economy? Briefly explain your answer. (2 marks)What impact will the increase in investment demand have on net capital outflow in the small open economy? Briefly explain your answer. (2 marks)Explain the long-run impact of the increase in investment demand on the real exchange rate and net exports. Briefly explain your answers by referring to the affected curves in the market for foreign exchange. (2 marks)
Upgrade your grade with Knowee
Get personalized homework help. Review tough concepts in more detail, or go deeper into your topic by exploring other relevant questions.