Question

 Consider a hypothetical open economy. The following table presents data on the relationship between various real interest rates and national saving, domestic investment, and net capital outflow in this economy, where the currency is the dollar. Assume that the economy is currently experiencing a balanced government budget.

 Given the information in the preceding table, use the blue points (circle symbol) to plot the demand for loanable funds. Next, use the orange points (square symbol) to plot the supply of loanable funds. Finally, use the black point (cross symbol) to indicate the equilibrium in this market.

 On the following graph, plot the relationship between the real interest rate and net capital outflow by using the green points (triangle symbol) to plot the points from the initial data table. Then use the black point (cross symbol) to indicate the level of net capital outflow at the equilibrium real interest rate you derived in the previous graph.

 Because of the relationship between net capital outflow and net exports, the level of net capital outflow at the equilibrium real interest rate implies that the economy is experiencing _______ 

 Now, suppose the government is experiencing a budget deficit. This means that _______  which leads to _______  loanable funds.

 After the budget deficit occurs, suppose the new equilibrium real interest rate is 5%. The following graph shows the demand curve in the foreign-currency exchange market.

 Use the green line (triangle symbol) to show the supply curve in this market before the budget deficit. Then use the purple line (diamond symbol) to show the supply curve after the budget deficit.

 Summarize the effects of a budget deficit by filling in the following table.

Answer 1

National saving is supply curve

Domestic investment is demand curve

At eqm, both intersect, at r = 3.5,

So corresponding to r = 3.5, NCO = 7.5

Now as NCO > 0, so experiencing trade surplus

if budget deficit , then

1) national saving will decrease

2) decrease in supply of

At initial eqm , Quantity of dollars equal NCO

So initial supply is Vertical at NCO = 7.5

New supply , NCO = value at 5% = 0

So vertical at 0

Table

Effects of budget deficit

	Real Interest rate	exchange rate	Trade balance
Effect	Increase	Increase	deficit