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Principles of Economics (MindTap C...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781305585126

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Principles of Economics (MindTap C...

8th Edition
N. Gregory Mankiw
Publisher: Cengage Learning
ISBN: 9781305585126
Chapter 32.3, Problem 3QQ
Textbook Problem
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Suppose that Americans decided to spend a smaller fraction of their incomes. What would be the effect on saving, investment, interest rates, the real exchange rate, and the trade balance?

To determine
The impact of smaller spending on savings, investment, interest rate, real exchange rate, and the trade balance of the economy.

Explanation of Solution

The foreign exchange market is the place of market where the participants are able to buy and sell the different foreign currencies with exchange to the domestic currency. Here, the lonable fund interest rate theory applies. The lonable fund includes all the forms of credit of the economy, which includes the loans, bonds, and the savings deposits.

When the people in the economy decide to spend a smaller portion of their income, the larger portion that is unspent by them will turn to be the savings of the population. As a result, the private savings of the economy will increase, and this would increase the national savings of the economy because it is the summation of the private savings and the government savings. Since the national savings is the supply of the lonable funds in the lonable fund market, the increase in the national savings will lead to the shift in the supply curve of lonable funds in the market toward the right. As a result of the unchanged demand and increased supply, the real interest rate of the economy will fall.

When the real interest rate in the economy falls, there will be less incentive to save in the economy and thus the capital of the economy will floe outward where the real interest rate is higher than the domestic real interest rate. So, the fall in the domestic real interest rate would lead to the increased capital outflow from the economy...

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