The diagram below represents the market for loanable funds and the market for foreign-currency exchange in Mexico. Use the diagram to answer the following questions.
Figure 32-6

-Refer to Figure 32-6.Suppose the Mexican economy starts at r₀ and E₁.Which of the following new equilibrium is consistent with capital flight?

Question

The diagram below represents the market for loanable funds and the market for foreign-currency exchange in Mexico. Use the diagram to answer the following questions.
Figure 32-6
 
-Refer to Figure 32-6.Suppose the Mexican economy starts at r₀ and E₁.Which of the following new equilibrium is consistent with capital flight?

Quizplus · Accepted Answer

Capital flight refers to the situation when investors withdraw their investments from a country due to concerns about the economic or political situation. In this case, capital flight in Mexico would result in a decrease in the supply of loanable funds (shifting the supply curve to the left), and an increase in the demand for foreign currency (shifting the demand curve to the right). This would lead to a new equilibrium at a lower interest rate (r₁) and a lower exchange rate (E₀). Therefore, option B (r₁ and E₀) is the correct answer. Option A (rₒ and E₀) is incorrect because it only represents a decrease in demand for loanable funds without a corresponding increase in demand for foreign currency. Option C (r₁ and E₁) is incorrect because it represents an increase in both the demand for loanable funds and the demand for foreign currency, which is not consistent with capital flight.

The Diagram Below Represents the Market for Loanable Funds and the Market