10. In Mankiw’s model of a small open economy, domestic interest rates are set by the...

10. In Mankiw’s model of a small open economy, domestic interest rates are set by the world’s market for loanable funds, rather than by domestic saving and investment.

a. What are the two simplifying assumptions in the model that disconnect domestic interest rates from domestic saving and investment?

b. What is determined by domestic saving and investment in the model?

Expert Solution

If the economy is small or having a better capital mobility are importent simplifying assumptions in the Mankiw's model of small open economy. The main reason behind the economy is small because of the economic varibles are not influenced in a world market.And also the perfect mobility in the domestic market participants take a loanable fund borrow in the domestic interst rate become increase time. So the domestic and world market interest rate become high when the time of borrow at the respective of domestic and world interst rate become equal.

b.Based on this model domestic saving and investment can determine through the rate of interst and the net exports in a country's economy.if trade balance occur the result from the interest rate of domestic and world market equal to the saving and investment. And also it will not always trade balance but also occur deduct or surplus in the trade when the unequal of interst rate.

Rahul Sunny answered 2 years ago

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