Consider a small open economy that has balanced trade. The economy enacts an investment tax credit....

Consider a small open economy that has balanced trade. The economy enacts an investment tax credit.

As a result, national savings will ________ and the world interest rate will ___________.

a) increase; rise

b) decrease; rise

c) increase; fall

d) decrease; fall

e) remain the same; remain the same

Expert Solution

Option E

This is a small open economy so it cannot influence the rate of interest. Also note that saving is fixed in this economy which means National savings exhibit a vertical line. When there is an increase in investment demand due to investment tax credit, the investment demand function shifts to the right. but the interest rate cannot be increased which means at the world interest rate there is now a trade deficit. saving is unchanged and investment has increased which has resulted in reduced net exports.

Rahul Sunny answered 2 years ago

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