Suppose That the World Consists of Only Two Countries, a and B

question 8

Essay

Suppose that the world consists of only two countries, A and B, of relatively equal sizes. The world interest rate in such a model is some average of the autarkic (no trade) interest rates in each of the two countries.
a. Draw "parallel" loanable funds markets for the two countries and show the position of the world interest rate. (Hint: What relationship must exist between the NCOs of the two countries?)
b. Suppose country A enacts laws that induce people to save more. Show the effects of such laws on each country's domestic amounts saved and invested.
c. In the currency-exchange diagrams for both countries, show the effect of country A's savings policies on both countries' exchange rates and net exports.

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Definitions:

Cost of Capital

The minimum return needed for a capital investment project, like constructing a new manufacturing facility, to be considered viable.

Risky Projects

Investments or projects that carry a high level of uncertainty regarding their future returns.

Safe Projects

These are investment ventures with a low risk of failure or loss, often characterized by predictable revenue streams or market demands.

Bankruptcy

A legal process through which individuals or businesses unable to meet their financial obligations can relieve their debts by transferring assets to a trustee.