In a short-run model of a large open economy, after net capital outflow is substituted for net exports in the IS curve:
A) the larger the absolute value of the responsiveness of net capital outflow with respect to the interest rate, the flatter the IS curve.
B) the larger the absolute value of the responsiveness of net capital outflow with respect to the interest rate, the steeper the IS curve.
C) if both domestic investment and net capital outflow are very responsive to the interest rate, they will tend to cancel each other out.
D) the slope of the IS curve depends only on the interest responsiveness of investment and the marginal propensity to consume.

Question

Quizplus · Accepted Answer

When net capital outflow is substituted for net exports in the IS equation, the interest responsiveness of net capital outflow affects the slope of the IS curve. Specifically, the larger the absolute value of the responsiveness of net capital outflow with respect to the interest rate, the flatter the IS curve. This is because a higher interest rate leads to a greater outflow of capital, reducing the supply of loanable funds and causing a decrease in investment and consumption, which in turn leads to a decrease in output and an increase in the interest rate. Therefore, a more responsive net capital outflow curve will flatten the IS curve.

In a Short-Run Model of a Large Open Economy, After