【正文】 2001 by Harcourt, Inc.。s domestic investment increases, in the long run, Canada39。 an export subsidy will not reduce the trade deficit.Figure 3078. Higher real interest rates in Europe lead to increased . net foreign investment. Higher net foreign investment leads to higher net exports, since in equilibrium net exports equal net foreign investment (NX=NFI). Figure 308 shows that the increase in net foreign investment leads to a lower real exchange rate, higher real interest rate, and increased net exports. Figure 3089. a. If the elasticity of . net foreign investment with respect to the real interest rate is very high, the lower real interest rate that occurs because of the increase in private saving will increase net foreign investment a lot, so . domestic investment won39。 the demand for loanable funds es from domestic investment and net foreign investment. The supply of dollars in the market for foreign exchange es from net foreign investment。 the quantity of dollars exchanged is on the horizontal axis.b. The demand for dollars will be downwardsloping because of the inverse relationship between the real exchange rate and the quantity of dollars demanded.c. The supply of dollars will be a vertical line because of the fact that changes in the real exchange rate have no influence on the quantity of dollars supplied.Figure 302Supply (NFI)Real Exchange Ratereal e*Demand (NX)Quantity of DollarsRemind students that net exports represent the demand for dollars by placing “NX” in parentheses next to the demand curve. Show that net foreign investment represents the supply of dollars by placing “NFI” in parentheses next to the supply curve.6. The real exchange rate adjusts to balance the supply and demand for dollars.a. If the real exchange rate was lower than real e*, the quantity of dollars demanded would be greater than the quantity of dollars supplied and there would be upward pressure on the real exchange rate.b. If the real exchange rate was higher than real e*, the quantity of dollars demanded would be less than the quantity of dollars supplied and there would be downward pressure on the real exchange rate.7. At the equilibrium real exchange rate, the demand for dollars to buy net exports exactly balances the supply of dollars to be exchanged into foreign currency to buy assets abroad.C. FYI: PurchasingPower Parity as a Special Case1. Purchasingpower parity suggests that a dollar must buy the same quantity of goods and services in every country. As a result, the real exchange rate is fixed and the nominal exchange rate is determined by the price levels in the two countries.2. Purchasingpower parity assumes that international trade responds quickly to international price differences.a. If goods were cheaper in one country than another, they would be exported from the country where they are cheaper and imported into the second country where the prices are higher.b. This would continue until the price differential disappears.c. Because net exports are so responsive to small changes in the real exchange rate, purchasingpower parity implies that the demand for dollars would be horizontal. Thus, purchasingpower parity is simply a special case of the model of the foreigncurrency exchange market.d. However, it is more realistic to draw the demand curve downwardsloping.II. Equilibrium in the Open EconomyA. Net Foreign Investment: the Link between the Two Markets1. In the market for loanable funds, net foreign investment is a part of the demand.2. In the foreigncurrency exchange market, net foreign investment is the supply of dollars.3. This means that net foreign investment is the variable that links the two markets.Figure 303Real Interest RateNFI0NFI4. The key determinant of net foreign investment is the real interest rate. 5. We can show the relationship between net foreign investment and the real interest rate graphically.a. When the real interest rate is high, owning domestic assets is more attractive and thus, net foreign investment is low.Again, you may need to write the equation for net foreign investment on the board to demonstrate the inverse relationship between the real interest rate and net foreign investment.b. This inverse relationship implies that net foreign investment will be downwardsloping.c. Note that net foreign investment can be positive or negative.B. Simultaneous Equilibrium in Two MarketsStudents will be frightened by the next diagram showing the market for loanable funds and the market for foreigncurrency exchange, with the diagram of net foreign investment linking the two. Go through it very slowly. You will likely have to repeat the equilibrium process several times before students understand it.Figure 304rrS (saving)r*NFID (I+NFI)Q of loanable fundsNFIreal eS(NFI)real e*D (NX)Q of dollars1. The real interest rate is determined in the market for loanable funds.2. This real interest rate determines the level of net foreign investment.3. Because net foreign investment must be paid for with foreign currency, the quantity of net foreign investment determines the supply of dollars.4. The equilibrium real exchange rate brings into balance the quantity of dollars supplied and the quantity of dollars demanded.5. Thus, the real interest rate and the real exchange rate adjust simultaneously to balance supply and demand in the two markets. As they do so, they determine the levels of national savi