ECE 201 - Chapter A Macroeconomic Theory of the Open...

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Unformatted text preview: Chapter A Macroeconomic Theory of the Open Economy 14 Supply and Demand for Loanable Funds The market for loanable funds I n an open economy S = I + NCO Saving = Domestic investment + Net capital outf low Supply of loanable funds From national saving (S) Demand for loanable funds From domestic investment (I ) And net capital outf low (NCO) 2 Supply and Demand for Loanable Funds The market for loanable funds Loanable funds - inter preted as Domestically generat ed f low of resources available for capital accumulation Purchase of a capital asset Adds to the demand for loanable funds Asset locat ed at home: I Asset locat ed abroad: NCO I f NCO > 0, net outf low of capital - adds to demand 3 Supply and Demand for Loanable Funds The market for loanable funds Higher real interest rate Encourages people t o save I ncreases quantity of loanable funds supplied Discourages investment Decreases quantity of loanable funds demanded Discourages Amer icans from buying foreign assets Reduces U.S. net capital outf low Encourages foreigners to buy U.S. assets Reduces U.S. net capital outf low 4 Supply and Demand for Loanable Funds The market for loanable funds Supply of loanable funds Slopes upward Demand of loanable funds Slopes downward At equilibr ium interest rate Amount that people want t o save Exactly balances the desired quantities of domestic investment and net capital outf low 5 Figure Real Interest Rate The market for loanable funds 1 6 Quantity of Loanable Funds Equilibrium real interest rate Supply of loanable funds (from national saving) Demand for loanable funds (for domestic investment and net capital outflow) Equilibrium quantity The interest rate in an open economy, as in a closed economy, is determined by the supply and demand for loanable funds. National saving is the source of the supply of loanable funds. Domestic investment and net capital outflow are the sources of the demand for loanable funds. At the equilibrium interest rate, the amount that people want to save exactly balances the amount that people want to borrow for the purpose of buying domestic capital and foreign assets. Market for Foreign-Cur rency Exchange The market for foreign-cur rency exchange I dentity: NCO = NX Net capital outf low = Net expor ts I f trade sur plus, NX > 0 Foreigners buy more U.S. goods & ser vices than Amer icans buy foreign goods & ser vices Amer icans use foreign cur rency to buy foreign assets 7 Market for Foreign-Cur rency Exchange The market for foreign-cur rency exchange I f trade deficit, NX < 0 Amer icans buy more foreign goods & ser vices than foreigners buy U.S. goods & ser vices Some of this spending is financed by sending Amer ican assets abroad Foreign capital is f lowing into U.S....
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ECE 201 - Chapter A Macroeconomic Theory of the Open...

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