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Question
Microeconomics
Posted 7 months ago
A budget surplus in Hamsterville has decreased the real interest rate there. Assume there are no restrictions on the flow of assets between Hamsterville and Maxistan.
What will happen to the value of Hamsterville's currency and the value of Hamsterville's exports
Choose 1 answer:
(A) Hamsterville's currency depreciates and its exports are unaffected.
(B) There is no impact on Hamsterville's currency or exports
(c) Hamsterville's currency appreciates and its exports decrease.
(D) Hamsterville's currency depreciates and its exports increase.
(E) Hamsterville's currency is unaffected and its exports decrease.
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Answer from Sia
Posted 7 months ago
Solution
a
Budget Surplus and Real Interest Rate: A budget surplus in Hamsterville leads to a decrease in the real interest rate. This is because the government is spending less than it is earning, which reduces the demand for borrowing and thus lowers interest rates
b
Capital Flows: With no restrictions on the flow of assets between Hamsterville and Maxistan, investors will seek higher returns. Lower real interest rates in Hamsterville will make it less attractive for investors compared to Maxistan, leading to capital outflows from Hamsterville
c
Currency Depreciation: Capital outflows from Hamsterville will increase the supply of Hamsterville's currency in the foreign exchange market, leading to its depreciation
d
Impact on Exports: A depreciated currency makes Hamsterville's goods cheaper for foreign buyers, thus increasing its exports
Answer
(D) Hamsterville's currency depreciates and its exports increase.
Key Concept
Budget surplus and its impact on real interest rates, currency value, and exports in an open economy
Explanation
A budget surplus decreases the real interest rate, leading to capital outflows and currency depreciation. The depreciated currency makes exports cheaper, thus increasing them.
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