Question

1) Consider a small, open economy starting off with balanced trade. If the economy experiences an increase in demand for economic investment, the result will be _____________ in the world real interest rate and the introduction of a trade _________.

a. no change; deficit

b. an increase; surplus

c. no change; surplus

d. a decrease; deficit

2) Consider a small, open economy that starts off in balanced trade. If its government raises taxes for fiscal policy, we expect to see its net exports __________ and the real exchange rate ___________.

a. rise; rise

b. fall; fall

c. rise; fall

d. fall; rise

Answer 1

Answer: 1) c. no change ; surplus

if demand for domestic investment increases it will lead to rise in interest rate it will not affect the world real interest rate as the country is small but there will be trade surplus as more people from foreign will save in the domestic banks due to high interest rates it will increase inflow of capital and tarde will be in surplus.

Answer : 2) d. fall ; rise

The increase in taxes in domestic country will increase the prices of goods and services which will make exports costly so demand for exports will decrease which will lead to fall in net exports as net exports = export – imports, the imports will be more than exports

It will decrease the value of currency relative to foreign currency so the real exchange rate will increase