Japan, the European Union, Canada, and Mexico have flexible exchange rates.
Suppose Japan attracts an increased amount of investment from the European Union.
Using a correctly labeled graph of the loanable funds market in Japan, show the effect of the increase in foreign investment on the real interest rate in Japan.
MY QUESTION: My doesn't DEMAND shift right for Japan's foreign investment? (correct answer is that supply shifts right)
AD shifts right overall, but in the market for loanable funds the supply shifts right, because at any given interest rate, there will be more loanable funds available
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The increase in foreign investment from the European Union in Japan will actually cause a shift in the supply of loanable funds in Japan, rather than the demand. Let's walk through the logic behind it.
1. Initially, let's assume an equilibrium in the loanable funds market in Japan. On the vertical axis, we have the real interest rate in Japan, and on the horizontal axis, we have the quantity of loanable funds. The intersection of the supply and demand curves represents the equilibrium interest rate and quantity of loanable funds.
2. When the European Union increases its investment in Japan, it means that there will be more funds available for borrowing in Japan's loanable funds market. This increases the supply of loanable funds in Japan.
3. With the increase in the supply of loanable funds, the supply curve in the loanable funds market will shift to the right. This is because there are now more funds available for borrowers in Japan, which will lead to a decrease in the real interest rate.
4. As a result, the equilibrium real interest rate in Japan will decrease, and the quantity of loanable funds borrowed in Japan will increase.
In summary, the increase in foreign investment from the European Union in Japan will cause a rightward shift in the supply curve of loanable funds, leading to a decrease in the real interest rate in Japan.
To understand why the increase in foreign investment in Japan would shift the supply curve in the loanable funds market instead of the demand curve, let's first review the loanable funds market.
The loanable funds market represents the interaction between savers (households and businesses) who supply funds, and borrowers (investors) who demand funds for investment. The supply of loanable funds comes from savers who deposit money in banks or other financial institutions, while the demand for loanable funds comes from investors who borrow money to finance investment projects.
In the case of Japan attracting an increased amount of investment from the European Union, this implies that there is a higher demand for funds for investment in Japan. However, this does not necessarily mean that the demand for loanable funds in Japan will shift right. Instead, it is the supply of loanable funds that will shift right.
When foreign investors increase their investment in Japan, they will need to finance these investments. They can do so by either using their own savings or by borrowing funds locally. In this case, since the investment is coming from the European Union, it is likely that they will need to borrow funds in Japan's loanable funds market.
As a result, the increased foreign investment will lead to an increase in the supply of loanable funds in Japan's loanable funds market. The supply curve will shift rightward because there will be more funds available for lending to borrowers in the market.
On the other hand, the demand for loanable funds in Japan's loanable funds market may or may not change. It depends on factors such as the interest rate and the profitability of investment projects in Japan. If the interest rate remains unchanged and there are no significant changes in domestic investment, the demand for loanable funds may stay the same.
In conclusion, when Japan attracts an increased amount of investment from the European Union, the supply of loanable funds in Japan's loanable funds market will shift right, while the demand for loanable funds may or may not change.