Using a flow chart, illustrate the effects of a decrease in government spending (G) in a country with floating exchange rates and highly mobile international capital.
What will be an ideal response?
POSSIBLE RESPONSE: The flow-diagram below shows the effects of this contractionary fiscal policy in a country with floating exchange rates and highly mobile international capital.
*if capital is highly mobile
Initially, with the decrease in government spending, interest rates fall since the government lessens its amount of borrowing. Domestic production and income also fall along with the decrease in government spending. With the fall in interest rates, capital flows out of the nation. With the fall in income level, aggregate demand falls. so the price level also declines. This, along with fall in income improves the current account balance. The domestic currency will depreciate. Because the capital is highly mobile internationally, the capital outflow is larger than the improvement in the current account balance. The currency depreciation discourages imports and encourages exports, so the current account improves. The ultimate effect is that domestic product and income fall, but not by as much as they would fall if the exchange rate did not change.
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A) the aggregate supply curve above the aggregate demand curve B) the aggregate supply curve below the aggregate demand curve C) the aggregate demand curve above the aggregate supply curve D) the aggregate demand curve below the aggregate supply curve E) none of the above
In the constant-growth dividend valuation model, the required rate of return on common stock (i.e., cost of equity capital) can be shown to be equal to the sum of the dividend yield plus the ____
a. yield-to-maturity b. present value yield c. risk-free rate d. dividend growth rate e. none of the above