What impact will the increase in investment demand have on net capital outflow in the small open economy? Briefly explain your answer. (2 marks)
Question
What impact will the increase in investment demand have on net capital outflow in the small open economy? Briefly explain your answer. (2 marks)
Solution
In a small open economy with perfect capital mobility, an increase in investment demand means that more funds are needed for investment purposes. Since the real interest rate is determined by the world interest rate and does not change, the additional funds for investment will be borrowed from abroad. This means that there will be a decrease in net capital outflow, as more capital is flowing into the country for investment purposes. In other words, the country is borrowing more from the rest of the world, which reduces its net lending to the rest of the world (or increases its net borrowing from the rest of the world).
Similar Questions
Consider the classical model of a small open economy with perfect capital mobility. Suppose domestic political stability improves and optimism about future conditions increases, causing firms to raise their investment sharply.Based on the above information, answer the following questions.What impact will the increase in investment demand have on the real interest rate of the small open economy? Briefly explain your answer. (2 marks)What impact will the increase in investment demand have on net capital outflow in the small open economy? Briefly explain your answer. (2 marks)Explain the long-run impact of the increase in investment demand on the real exchange rate and net exports. Briefly explain your answers by referring to the affected curves in the market for foreign exchange. (2 marks)
What impact will the increase in investment demand have on the real interest rate of the small open economy? Briefly explain your answer. (2 marks)
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