Consider a small open economy that is in equilibrium with a current account surp
ID: 1120175 • Letter: C
Question
Consider a small open economy that is in equilibrium with a current account surplus. An increase in future marginal product of capital results in:
a. a leftward shift in the investment curve, so S is unchanged, I falls, and CA rises.
b. a leftward shift in the investment curve, so S is unchanged, I falls, and CA falls.
c. a rightward shift in the investment curve, so S is unchanged, I rises, and CA falls.
d. a rightward shift in the investment curve, so S falls, I rises, and CA falls.
Please explain the answer also.
Explanation / Answer
c. a rightward shift in the investment curve, so S is unchanged, I rises, and CA falls.
An increase in future marginal product of capital will shift the investment curve to the right. However, the savings curve will remain unaffected. As a result, the equilibrium level of interest rate and investment will increase. At a higher interest rate, more capital will be attracted to the economy. With an increase in demand for its domestic currency, it will appreciate against foreign currency. With an appreciation, the demand for domestic will be negatively affected. Thus, the current account balance will worsen