Use the open economy macro model (the one with 3 diagrams) to illustrate what will happen...

Use the open economy macro model (the one with 3 diagrams) to illustrate what will happen if the government runs a bigger budget surplus. Answer the following:

(a) (2 points) Tell me which curve or curves move.
(b) (2 points) Tell me which direction the curve or curves move in.
(c) (2 points) Tell me what happens to Savings in equilibrium.
(d) (2 points) Tell me what happens to Investment Plus Net Capital Outflow in equilibrium.

Expert Solution

If the government runs a bigger budget surplus-

a) Ans Suppy of lonable funds curve moves

b) Ans The supply of lonable funds curve move downwards to the right.

c) At the new equilibrium point, Savings increase

d) Ans At the new equilibrium Investment plus Net Capital Outflow increases.

This is shown in figure 1-Whena government runs a budget surplus, it increases the quantity of available lonable funds. Thus, shifting S0 to S1 to right. This happens because government revenues exceeds its expenditures. Therefore it has positive savings, which increases total savings. shifting the supply of lonable funds reduces the real interest rate. This reduction in the real interest rate increases net capital outflow.

Rahul Sunny answered 2 years ago

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