Question

1. Assume that an increase in government spending increases the budget deficit in Country A.

(a) Using a correctly labeled graph of the loanable funds market, show the effect of the increase in Country A’s budget deficit on the real interest rate.

(b) Given your answer in (a), what is the effect on business investment in Country A?

(c) The exchange rate between Country A’s dollar and Country B’s peso is determined in a flexible exchange market. Using a correctly labeled graph of the foreign exchange market for Country A’s dollar, show how the interest rate change you identified in