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Short-run Fluctuations in an Open EconomyV.Tutor

# Short-run Fluctuations in an Open EconomyV.Tutor - The BP...

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1 Short-run Fluctuations in an Open Economy Tutional BBA International Economics. 2 The BP Curve BP curve – a curve that represents combinations of interest rates and income levels at a given exchange rate at which the Balance of payment is in equilibrium. CA deficit/surplus CA Y Y l Î e constant Î Im l Î CA ………. 3 KA i KA deficit/surplus i l Î Cap …… Î KA ……… i Y BP Curve 4 If income increases, the CA will be in deficit. To keep the BP in equilibrium, the interest rate must rise enough to bring the KA into surplus to offset. A rise in income requires a rise in interest rate. A decline in income require a decline in interest rates. i Y BP Curve Surplus zone Deficit Zone A At point A, the BP is in surplus b/c, the interest is higher than the interest rate that is Consistent with a BP of equilibrium.

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5 The slope of the BP curve. Î Depends on 2 factors. 1. The responsiveness of capital flows to interest. 2. The responsiveness of imports to income. Î MPM •As cap flows become more responsive to diff between domestic and world i. Î BP flatter. •As import become more responsive to change in income (MPM increase) Î BP steeper. 6 Policies that shift the BP curve 1. Exchange rates policies. change e Î BP shift to new equilibrium BP 0 A • Initially, at A, BP = 0. • e Depre Î X l & Im l Î at A BP surplus • To equilibrium, Y l or i l • If i l Î Move to point B • If Y l Î Move to point C • The BP 1 represents all combinations of Y and i at which BP = 0. • Depre Î BP shift ………. . • Appre Î BP shift ……………. 7 Policies that shift the BP curve 2. Import control and Export Drives. Import control (Tariff, Quota and VER) Import control Î Im l Î CA ……… A Import control shift BP to the right. • Y must l or i must l to keep BP = 0 8 Policies that shift the BP curve 2. Import control and Export Drives.
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Short-run Fluctuations in an Open EconomyV.Tutor - The BP...

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