ECO-202 Quiz 7 Notes
For any given real exchange rate, net exports will increase when the US government levies a
tariff. According to this concept, this alteration increases the demand for dollars, which raises the
real exchange rate. The dollar has therefore increased in value. Remember that the net capital
outflow, which is solely impacted by the real interest rate and not the real exchange rate, is what
determines the supply curve in our model of the foreign-currency exchange market. As a result,
in this situation, the supply curve does not change. No area of the market for loanable money
changes when the government imposes a tax on items made abroad. This covers the supply of
loanable funds (national saving), the real interest rate, and the demand for loanable funds
(domestic investment and net capital outflow). The rise in the real exchange rate also dampens
net exports, counteracting the initial effect of the tariff, even as net exports rise for any given real
exchange rate, increasing demand for dollars. The lobbyists were wrong in their first estimate
since the outcome is that net exports remain unchanged.
The point at which the supply and demand curves in the market for loanable funds cross is the
equilibrium interest rate. This happens with a 4% interest rate. The NCO curve may be used to
calculate the amount of net capital outflow that corresponds to this interest rate, which is
equivalent to $1 billion. For every given real interest rate, net capital outflow in Mexico rises if
investors choose to shift their money to safer havens. The NCO curve moves to the right as a
result of this. Net capital outflows and domestic investment make up the demand for loanable
funds, and as a result, the demand for loanable funds in Mexico rises, which in turn pushes up
the real lending rate. Following the change, the equilibrium interest rate is 5%. Using the graph
on the right as a reference, the increased rate translates to a new NCO level of $1.5 billion.
For any given real interest rate, external debt causes a rise in net capital outflow, which raises the
demand for loanable funds. As a result, there is more net capital outflow, which pushes the real
interest rate up. The supply curve in the foreign exchange market moves to the right because it is
equivalent to the amount of net capital outflow. This results in a decline in the real exchange rate
for pesos (the peso depreciates), which raises the attractiveness of Mexican goods and services
on the global market and raises trade surplus.
This policy would cause the economy to go from result A to outcome B. The point you depicted
in purple on the previous graph would travel along the short-run Phillips curve to the point you
plot in green because the short-run Phillips curve passes through the inflation/unemployment
combinations that correspond to points A and B. This demonstrates the short-term tradeoff
between unemployment and inflation that the government confronts. Increasing output and
decreasing unemployment result from an expansionary strategy, while inflation grows. On the
other hand, if it employs a contractionary strategy to control inflation, output declines and
unemployment increases.
