Question

it's my question

Graphically illustrate the equilibrium of an open economy. Discuss also the off-the equilibrium situations condition as well as the equilibrium.

please do not write handwriting because I don't understand your handwriting  and please explain in detail

thanks

Answer 1

Open economy equilibrium:

An open economy is categorized by an interest rate (i) equal to the world interest rate (i*). At a point where IS and LM curves intersect at an interest rate equal to i*, equilibrium exist at Y. This is because there is no flow of capital as both the markets (Home and rest of the world) offers same rates of return on capital.

Cases of disequilibrium:

Case 1: when i>i*

Home interest rate is more than world interest rate (denoted by i'). It means Home will attract capital as it promises returns more than the rest of the world. Hence, LM curve will shift to the right. Interest rate at home will keep falling until it equals i*. AS a result of low interest rate, output will also increase (Y' to Y).

Case 2:When i<i*

Home interest rate is less than world interest rate (denoted by i'). It means rest of the world will attract capital from home as returns from home market is less than the rest of the world. Hence, LM curve will shift to the left as capital leaves the home market. Interest rate at home will keep rising until it equals i*. AS a result of high interest rate, output will also fall (Y' to Y).