Theory of Open Economy Macroeconomics (Block 3)

Question 1

Market for loanable funds

Answer 1

• Supply side: Saving by households, firms, and governments.
• Demand side: Investment in physical and human capital.
• Identity: Saving = Investment + Net capital outflow.

Question 2

How real interest rate affects demand and supply

Answer 2

Higher real interest rates increase the supply of loanable funds (saving) and decrease the demand for loanable funds (investment).

Question 3

Market for foreign currency exchange

Answer 3

• Supply side: The supply of a country’s currency in the foreign exchange market comes from the sale of goods and services abroad and from net capital outflow.
• Demand side: The demand for a country’s currency comes from the purchase of foreign goods and services and from foreigners investing in the country.
• Identity: The supply of a country’s currency equals the demand for foreign currency.

Question 4

How real exchange rate affects demand and supply

Answer 4

An increase in the real exchange rate decreases the quantity demanded of the domestic currency and increases the quantity supplied.

Question 5

Policies affecting these markets

Answer 5

Fiscal policies (government spending and taxation), monetary policies (interest rate adjustments), trade policies (tariffs and quotas), and exchange rate policies (currency interventions).