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Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985

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BuyFindarrow_forward

Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985
Textbook Problem

If business leaders in Great Britain become more confident in their economy, their optimism will induce them to increase investment, causing the British pound to _________ and pushing the British trade balance toward _________.

a. appreciate, deficit

b. appreciate, surplus

c. depreciate, deficit

d. depreciate, surplus

To determine

The impact of increased investment on exchange rate and trade balance.

Explanation

The interest rate determined at the supply and demand intersection in the lonable fund market is known as the real interest rate; the same rate determined in the currency exchange market is known as the real exchange rate.

Option (a):

The increased investment in the economy increases the demand for the currency in the economy. The higher demand for the currency for the investment purpose increases the interest rate of the economy. This leads to an increased capital inflow, which makes the domestic currency to appreciate and become stronger. When the domestic currency becomes stronger, the domestic goods will become costly and it will reduce the exports of the economy and increase the imports of the economy. As a result, the trade balance will move towards the trade deficit. Thus, option 'a' is correct.

Option (b):

The increased investment in the economy increases the demand for the currency in the economy. The higher demand for the currency for the investment purpose increases the interest rate of the economy. This leads to an increased capital inflow, which makes the domestic currency to appreciate and become stronger. When the domestic currency becomes stronger, the domestic goods will become costly and it will reduce the exports of the economy and increase the imports of the economy. As a result, the trade balance will move towards the trade deficit...

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