Question

Oceania is a small open economy. Suppose that a large number of foreign countries begin to subsidize investment by it an investment tax credit (while adjusting other taxes to hold their to revenue constant), but Oceania does not institute such an investment subsidy.
a. What happens to world investment demand as a function of the world interest rate?
b. What happens to the world interest rate?
c. What happens to investment in Oceania?
d. What happens to Oceania's trade balance?
e. What happens to Oceania's real exchange rate?

Answer 1

Answer:

a) shift upwards

b) Rise from "r1 to r2"

c) Decrease

d) Trade surplus

e) Fall

Explanation:

A) The world investment curve which is a function of interest  will shift upwards

b) The world interest rate will rise from "r1 to r2"  ( i.e. increase in cost of acquiring world investment )

C) The Investment in Oceania will decrease because the increase in world interest rate will have a direct impact on  an open economy

D) Oceania's trade balance will experience a trade surplus because there will be an increase in exports and a decrease in imports due to the decrease in domestic investment

E) Oceania real exchange rate will fall  because more people will be wiling to save due to the high interest rate rather than investing