--%>

Domestic Investment & Economies

Question:

How will a fall in domestic investment affect the trade surplus and net capital outflows in the domestic economy, the trade deficit and capital inflows in the rest of the world, investment in both economies, and the world real interest rate?

Answer

A fall in domestic investment means that the production activities in the economy will decrease. This translates into a shrinking of the aggregate production in the economy, as there will be no production activities and the existing production activities will also decrease. This will lead to fall in employment level and also the aggregate output. The interest rate will also fall as the money supply is fixed while the money demand falls. Therefore, the real interest in the domestic economy will fall.

Now, this fall in interest rate will mean that there will be a capital outflow as the returns on investments in the domestic currency falls. This, in turn, will lead to a depreciation of currency as the demand for the domestic currency falls due to the capital flow. Depreciation of currency will directly impact exports and imports. For the foreign consumers this will mean that our products become cheaper. Therefore, exports will rise. Similarly, imports will become costlier for as the foreign currency will become dearer for us, leading into an increase in prices of imports. The increased exports and decreased imports will ultimately lead to an increase in the trade surplus.

Therefore, there will an increase in the capital inflow of other economies which have interest rates higher than the domestic economy.  The trade deficit of rest of the world will increase, following the opposite pattern of that of the domestic economy. Also, if the domestic economy is small, there will not be any change in the world real interest rate. However, if the domestic economy is big, there will be a fall in world interest rate, as the fall in demand in the domestic economy will affect the world demand, resulting into a fall in interest rates.

   Related Questions in Macroeconomics

  • Q : Consumer Surplus definition Can someone

    Can someone help me in finding out the right answer from the given options. The basic difference between the dollar amounts people would willingly to pay for a particular quantity of a good and the amounts that they do pay at a particular market price is termed as: (1

  • Q : If households If households become more

    If households become more willing to hold less cash and more stocks or bonds, the

  • Q : Potential GDP The hypothetical

    The hypothetical information in the following table shows what the economic situation will be in 2015 if the Fed does not use monetary policy: Year Potential GDP Real GDP Price Level 2014 $15.2 trillion $15.2 trillion 110.0 2015 $15.6 trillion $15.8 trillion

  • Q : Value of exports of goods A country’s

    A country’s balance of trade is Rs. 75 crores. The value of imports of goods is Rs. 100 crores. What is the value of exports of goods?

  • Q : Goals of Microeconomic Hello guys I

    Hello guys I need your advice. Please advise your view for following economics problems. Microeconomic goals consist of: (w) full employment. (x) efficient allotments of resources. (y) price level stability. (z) ec

  • Q : Define Devaluation Devaluation means

    Devaluation means decrease in the external value of a country’s currency as an aware policy measure adopted by the Government of a country. In another words, we make our currency less costly in terms of foreign currency. This builds our goods ch

  • Q : Physical quality of life index DISCUSS

    DISCUSS the experience of high GNP countries and low GNP with regard to PQLI.

  • Q : Total revenue when price modify When

    When total revenue to a firm is unaffected by small price modifications, then demand is: (i) Relatively price elastic. (ii) Relatively price inelastic. (iii) Unitarily price elastic. (iv) Vertical. (v) Horizontal. Can someone help

  • Q : Diminishing prices raising total revenue

    Diminishing prices will raise total revenue from DVD game sales at each and every price: (1) On this demand curve. (2) Beneath $25. (3) Above $25. (4) Beneath $30.

    Q : Value of MPC when MPS is zero Determine

    Determine the value of MPC whenever MPS is zero? Answer: Whenever MPS = 0, MPC = 1 – 0 = 1.