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Chapter 19/A Macroeconomic Theory of the Open Economy ❖ 325
10.
Case Study: Capital Flows from China
a. What happens if a country’s government encourages capital to flow to other countries?
Figure 7
ALTERNATIVE CLASSROOM EXAMPLE:
Suppose that investors feel very confident about the prospects for investment in Brazilian
assets.
In this case (from the perspective of Brazil):
1. The demand for loanable funds will shift left because
NCO
decreases.
326 ❖ Chapter 19/A Macroeconomic Theory of the Open Economy
c. In recent years, this has been the case with China as its government has tried to depress
its currency.
11.
In the News: Is a Strong Currency Always in a Nation's Interest
a. Politicians assert that the U.S. favors a strong dollar.
b. This article from
The New York Times
discusses when a strong or weak currency can be
beneficial.
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
1. The supply of loanable funds comes from national saving. The demand for loanable funds
Activity 1—Open Economy Article
Type: Take-home assignment
Topics: Open-economy macroeconomics
Class limitations: Works in any class
Purpose
This assignment helps students apply the open-economy macro model to world events.
Instructions
This model is often confusing to students. This assignment has them work through an
example of real-world events that relate to international macroeconomics. Students may need
some direction in finding appropriate topics such as interest rate changes, changes in net
capital outflow, or changes in net exports.
Assignment
1. Find an article in a recent newspaper or magazine illustrating a change that will affect
Chapter 19/A Macroeconomic Theory of the Open Economy ❖ 327
3. If Americans decided to spend a smaller fraction of their incomes, the increase in saving
Questions for Review
1. The supply of loanable funds comes from national saving; the demand for loanable funds
comes from domestic investment and net capital outflow. The supply of dollars in the market
328 ❖ Chapter 19/A Macroeconomic Theory of the Open Economy
3. If a union of textile workers encourages people to buy only American-made clothes, imports
4. Capital flight is a large and sudden movement of funds out of a country. Capital flight causes
Quick Check Multiple Choice
Chapter 19/A Macroeconomic Theory of the Open Economy ❖ 329
1. c
Problems and Applications
1. Japan generally runs a trade surplus because the Japanese saving rate is high relative to
2. a. If Congress passes an investment tax credit, it subsidizes domestic investment. The
330 ❖ Chapter 19/A Macroeconomic Theory of the Open Economy
3. a. A decline in the quality of U.S. goods at a given real exchange rate would reduce net
Figure 4
4. A reduction in restrictions of imports would reduce net exports at any given real exchange
rate, thus shifting the demand curve for dollars to the left. The shift of the demand curve for
Chapter 19/A Macroeconomic Theory of the Open Economy ❖ 331
332 ❖ Chapter 19/A Macroeconomic Theory of the Open Economy
6. An export subsidy increases net exports at any given real exchange rate, causing the demand
Chapter 19/A Macroeconomic Theory of the Open Economy ❖ 333
7. An export subsidy increases net exports at any given real exchange rate, causing the demand
for dollars in the foreign exchange market to shift to the right as shown in Figure 7. The
334 ❖ Chapter 19/A Macroeconomic Theory of the Open Economy
8. Higher real interest rates in Europe lead to increased U.S. net capital outflow. Higher net
capital outflow leads to higher net exports, because in equilibrium net exports equal net
9. a. If the elasticity of U.S. net capital outflow with respect to the real interest rate is very
