National savings in US is equal to 40 billion dollars. Suppose US is an open economy...

National savings in US is equal to 40 billion dollars. Suppose US is an open economy and the real interest rate on Canada bonds increases. All else equal, what would we expect to happen to US investment and net capital outflow? Select one:

a. Net capital outflow decreases and US investment increases.

b. Net capital outflow increases and US investment increases.

c. Net capital outflow increases and US investment decreases.

d. Net capital outflow decreases and US investment decreases.

Solutions

Expert Solution

Ans: The correct option is (C)

When the real interest rate on Canadian bonds increases, the investors in USA would like to divert their investment from USA to Canada in search of high real interest rate. It means, people would invest their money in Canadian bonds which are paying high real interest rate as compared to investment products in USA. Therefore, the net capital outflow increases from USA to Canada.

As the funds (Savings) goes into Canada, the funds (Savings) available in USA decreases to make loans and investment. So, the supply of loanable funds decreases and investment level decreases in the country.

Rahul Sunny answered 2 years ago

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