Question

            1.   Suppose that Canadian investors decide that investment opportunities in African countries have improved. What happens to Canadian net capital outflow? What happens to the Canadian real interest rate?

            2.   Suppose that Canadian citizens start saving more. What does this imply about the supply of loanable funds and the equilibrium real interest rate? What happens to the real exchange rate?

            3.   Explain how an increase in the price level changes interest rates. How does this change in interest rates lead to changes in investment and net exports?

            4.   Suppose that consumers become pessimistic about the future health of the economy, and so cut back on their consumption spending. What will happen to aggregate demand and to output? What might the government have to do to keep output stable?

 

Answer 1

1. Because investment opportunities in African countries have improved , so the Canadian net capital outflow will increase. This increases the Canadian demand for loanable funds , which in turn increases Canadian real interest rates.

2. As Canadian citizens start saving more ,supply of loanable funds increases. As a result equilibrium interest rate falls . Due to lower interest rate , Canadian net capital outflow rises, this increases make supply of Canadian dollars shift to the right. As a result , real exchange rate of of Canadian dollar depreciates.

3. When price level increases ,the power of money declines. People feel less wealthy and therefore lend less. This causes interest rate to rise, which discourage spending on investment goods , aggregate demand on goods and services decreases. While interest rate rise , supply of dollars in market for foreign currency falls. Therefore, dollar appreciate which decreases net exports.

4. As consumers become pessimistic about the future health of the economy ,they cut their expenditures so that aggregate demand shifts and output falls.The President and Congress could adjust fiscal policy to increase aggregate demand . They could either increase government spending or cut taxes or both.