Written Assignment 4
Answer all of the following questions. Title your assignment "Written Assignment 4," unless your mentor directs otherwise. This assignment covers text chapters 18 through 23. 1. Explain the relationship among savings, investment, and net capital outflow. Savings are equal to domestic investment + net capital outflow. In an open economy, both net capital outflow ( which is the purchase of foreign assets by domestic investors minus the purchase of domestic investments by foreigners) and savings and domestic investments are both ways of saving, and are both used to get the full picture of total saving. 2. Describe the economic logic behind the theory of purchasing-power parity (PPP). What factors might prevent PPP from holding true? The purchasing power parity tells us the a unit of any given currency should be able to buy the same quantity of goods in all countries. This principle is based on the fact that prices should remain constant for goods no matter where the goods are purchased, otherwise there is an opportunity for profit that was left un-exploited. The theory has 2 holes in it. Firstly, some goods are not easily traded, and secondly, some goods cannot easily be substituted for another. 3. Describe supply and demand in the market for loanable funds and the market for foreign currency exchange. How are these markets linked? Supply and demand of loanable funds is determined by the real interest rate. A higher interest rate causes people to save and raises supply where a lower real interest rate does the opposite. In the market for foreign currency exchange, the real exchange rate balances out supply and demand. A higher U.S. real exchange rate increases U.S. goods compared to foreign goods, and exports fall. These 2 markets are linked because between the 2 of them, they determine national saving, domestic investment, net capital exports and net exports. 4. What is capital flight? When a country experiences capital flight,...
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