After the budget deficit occurs, suppose the new equilibrium real interest rate is 6%. 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) toshow the supply curve after the budget deficit.REAL EXCHANGE RATE-20-15Market for Foreign-Currency Exchange-10-5108Effects of a Budget Deficit620 510QUANTITY OF DOLLARS (Billions)0Demand1520Summarize the effects of a budget deficit by filling in the following table.Initial SupplySupply with Deficit(?)Real Interest Rate Real Exchange Rate Trade Balance On the following graph, plot the relationship between the real interest rate and net capital outflow by using the green points (triangle symbol) to plotthe points from the initial data table. Then use the black point (X symbol) to indicate the level of net capital outflow at the equilibrium real interestrate you derived in the previous graph.REAL INTEREST RATE-20Net Capital Outflow-51084219-15-10051015NET CAPITAL OUTFLOW (Billions of dollars)20NCOEqm. NCOBecause of the relationship between net capital outflow and net exports, the level of net capital outflow at the equilibrium real interest rate impliesthat the economy is experiencingNow, suppose the government is experiencing a budget deficit. This means thatloanable funds.After the budget deficit occurs, suppose the new equilibrium real interest rate iscurrency exchange market.Use the green line (triangle symbol) to show the supply curve in this market befshow the supply curve after the budget deficit.national saving will increasenational saving will decreasedomestic investment will increasedomestic investment will decrease, which leads toemand curve in the foreign-purple line (diamond symbol) to

International Capital mobility is a very common phenomena which occurs in these times of globalized economies arising out of the interest rate differential which exist between countries . If the domestic rate of interest increases it would attract capital from abroad as the investors always tend to optimize their returns and vice - versa, Budget deficit refers to the excess spending of government over its revenues . And this excess expenses are made through borrowing from public issuing bonds or other means . This additional borrowing leads to increase in demand for loanable funds as government being a major player it affects rate of interests quite substantially in the money market . So , When government is facing bduget deficit . This means domestic investment would increase which leads to increase in demand of loanable funds , Increase in demand for loanable funds lead to rise in domestic interest rates , which would attract foreign capital . So , equilibrium capital outflow would be something like it is represented in below graph - Now, as there is capital inflow in the economy . There is an increase in demand for domestic currency in the forex market . This puts an appreciating pressure on domestic currency exchange rates . And with appreciation in exchange rates the exports would become expensive to foreigners and imports would be cheaper for domestic consumers . This deteriorate the trade balance . So , Budget Deficit leads to - Increase in Real interest rates Appreciation in exchange rates Deterioration of trade balance .

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After the budget deficit occurs, suppose the new equilibrium real interest rate is 6%. 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. Market for Foreign-Currency Exchange 10 Initial Supply ?

After the budget deficit occurs, suppose the new equilibrium real interest rate is 6%. 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. Market for Foreign-Currency Exchange 10 Initial Supply ?

ENGR.ECONOMIC ANALYSIS

14th Edition

ISBN:9780190931919

Author:NEWNAN

Publisher:NEWNAN

Chapter1: Making Economics Decisions

Section: Chapter Questions

Problem 1QTC

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