In the basic model of a small open economy,if the government encourages investment,say through an investment tax credit,investment:
A) increases and is financed through an increase in national saving.
B) increases and is financed through an increase in exports.
C) increases and is financed through an inflow of foreign capital.
D) does not increase; the interest rate rises instead.

Question

Quizplus · Accepted Answer

In the basic model of a small open economy, an investment tax credit encourages investment, which leads to an increase in the demand for loanable funds. Since national saving is fixed and the supply of loanable funds is limited, the interest rate rises. The higher interest rate attracts foreign capital inflow, which finances the increased investment. Therefore, choice C is the best answer.

In the Basic Model of a Small Open Economy,if the Government