2) Studies indicate that net exports and net capital outflows tend to be equal.
ID: 1097250 • Letter: 2
Question
2) Studies indicate that net exports and net capital outflows tend to be equal.
a) Why are net exports and net capital outflows tend to be equal? How does an increase in the price level change interest rates?
b) How does this change in interest rates lead to changes in investment and net exports?
3) Assume there is a decrease in the demand for goods and services, which leads to a decrease in the real GDP and eventually the economy into recession.
a) When the economy enters recession due to a decline in demand, what will happen to the price level?
b) Assume there is no government intervention. What will ensure that the economy still eventually gets back to the natural rate of output (real GDP)?
Explanation / Answer
Studies indicate that net exports and net capital outflows tend to be equal.
a) Why are net exports and net capital outflows tend to be equal? How does an increase in the price level change interest rates?
the net capital outflow and exports tend to be equal as for any purchase of exports in a country it has to make transactions or trade on assets for currencies so as to make payments for exports, these payment made is equal to the net exports.
when there is increase inprice level the purchasing power of people become less, thus tey do not tend to lend money or deposit them in banks, this again leads to stringent measures of bank raising interest as they have very less deposits to lend.
b) How does this change in interest rates lead to changes in investment and net exports?
As and when there is rise in interst rates, the dollar supply in the market decreases as people invest less on foreign securities and this in turn leads to the rise of value of dollar which reduces the net exports.
3) Assume there is a decrease in the demand for goods and services, which leads to a decrease in the real GDP and eventually the economy into recession.
a) When the economy enters recession due to a decline in demand, what will happen to the price level?
when the economy enters into recession due to decline in demand then even the price levels will decline .
b) Assume there is no government intervention. What will ensure that the economy still eventually gets back to the natural rate of output (real GDP)?
If the government do not intervene then the prices will fall drastically beyond the expected point by the people and they will start transacting in the low price levels. this will eventually lead to adjustments in price and wage levels. When explained through an aggregate supply curve the supply curve shifts to the right side.
When wages decline the cost of production also declines and manufacturers produce goods at any given price which subsequently shifts the aggregate supply curve to the right, this shift in the supply curve makes the output to return back to its normal rate.
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