Answer to Question #186142 in Macroeconomics for bryan

Question

. Triniland is recognized as a high-income economy by the World Bank. Assume that   households in Triniland decide to increase their savings for retirement.             (4 marks each)

(a)  Using a correctly labelled diagram of the loanable funds market, show how the increase in savings will affect the equilibrium real interest rate.

(b) Based on the real interest rate change identified in part (a), what will happen to Triniland’s purchases of foreign assets? Explain.

(c)  Consider the foreign exchange market for Triniland’s currency. 

Answer 1

$$Solution$$

a) An increase in savings in Triniland will affect the equilibrium interest rates as shown in the diagram below. The vertical axis is denoted by 'r.i.r' which is the real interest rate and horizontal axis as $Q_{LF}$ for quantity of loanable funds. The downward sloping demand curve is labelled $D_{LF}$ and an upward sloping curve labelled $S_{LF}$. An increase in savings will cause the supply of loanable funds to increase from $S_{LF1}\ to\ S_{LF2}\ and\ Q_{LF1}\ shifting\ to\ Q_{LF2}$ .

b) Triniland's purchases of foreign assets will result to an increase in the demand for loanable funds which are foreign assets.

c) The supply of loanable funds is positively related to the real interest rate, however due to the demand for foreign assets, the real interest rate in negatively related, therefore the demand for dollars will be negatively related to the real exchange rate.