Nations are becoming increasingly interdependent, and so domestic economic events and policies can..

Nations are becoming increasingly interdependent, and so domestic economic events and policies can have a significant effect on other countries economies. For example, a change in the budget deficit (def) of Country A may affect domestic interest rates (id). A change in domestic rates may affect capital flows from abroad (kf ), which may have an impact on the international value of the domestic currency (ed). A change in the value of the exchange rate usually has an impact on a countrys trade balance (tb), so that a decrease in the exchange rate (measured in units of domestic currency)

Nations are becoming increasingly interdependent, and so domestic economic events and policies can have a significant effect on other countries economies. For example, a change in the budget deficit (def) of Country A may affect domestic interest rates (id). A change in domestic rates may affect capital flows from abroad (kf ), which may have an impact on the international value of the domestic currency (ed). A change in the value of the exchange rate usually has an impact on a countrys trade balance (tb), so that a decrease in the exchange rate (measured in units of domestic currency) stimulates imports and depresses exports. The changing trade balance for Country B, which is simply the mirror image of the change to Country As trade balance, may lead to a change in economic activity in Country B(yf ). (a) Using the chain rule, express each of the given relationships as a derivative to create a chain that links Country As budget deficit and Country Bs economic activity (dYdDef). (b) Determine the direction of the impact (positive or negative) of each factor in the chain. (c) What is the ultimate effect of an increase in Country As budget deficit on Country Bs economic activity?

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