Question

6.According to the open economy macroeconomic model, which of the following statements is (are) correct?

(x)The usual effects of capital flight include a rightward shift of demand in the loanable funds marketand a rightward shift of the NCO curve,

(y)Capital flight typically causes a decrease in the domestic interest rate and an increase in NCO.

(z)Capital flight typically causes the real exchange rate of the domestic currency to depreciate because capital flight causes an increase in the supply of the currency in foreign currency exchange markets.

A.(x), (y) and (z)B. (x) and (y) only C.(x) and (z) only D.(y) and (z) onlyE.(x)only

According to the open-economy macro model, which of the following causes the real exchange rate of the United States dollar to depreciate?

(x)the United States government decreases the budget deficit

(y)the United States eliminates import quotas and tariffs.

(z)capital flight from the United States

A.(x), (y) and (z) B. (x) and (y) onlyC.(x) and (z) only D.(y) and (z) only E.(y) only

Answer 1

Question 6) correct answer is (A) statements x,y,z are correct

Capital flights basically mean that large quantities of assets or money are leaving an economy, which will shift the net capital outflow curve upwards, to show increasing net capital outflows. This will affect both the market for loanable funds and the market for foreign currency exchange. First, it will increase the demand for loanable funds (in order to increase the purchase of assets overseas), thereby increasing the domestic interest rate . Secondly, since people wants to convert their holdings in domestic currency into a more “secure” currency, supply of domestic currency rapidly increases, shifting the supply curve to the right. Hence, capital flight leads to a dissapearance of wealth and is usually accompanied by depreciation of domestic currency.

correct answer is (A) statements x,y,z are correct

suppose US government eliminates import quotas and tarriffs. For any given exchange rate, imports would be higher, implying that net exports (exports minus imports) would be lesser.Amerian consumers pays for imported goods in dollars and importers in US use theses dollars to buy foreign currency and pay for goods. Due to increased import demand, importers will buy more foreign currency thereby increasing demand for foreign currency. This means foreign currency becomes stronger whereas real exchange is lower. Therefore, elimination of quotas and tarriffs leads to depreciation of real exchange rate of US dollar

fall in government deficit increases national savings thereby increasing supply of loanable funds and reducing domestic interest rate. Lower interest rate increased both domestic investment and net capital outflow The rise in net capital outflow increases supply of dollars to be exchanged into foreign currency Thus exchange rate depreciates and net exports rise. Similar effects are observed in case of capital flight.