1.5. Suppose that Northlandia and Southlandia are the only two trading countries in the world, that each nation runs a balance of payments on both current and financial accounts equal to zero, and that each nation sees the other’s assets as identical to its own. Using the accompanying diagrams, explain how the demand and supply of loanable funds, the interest rate, and the balance of payments on current and financial accounts will change in each country if international capital flows are possible.

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Interest rate 12% 10 (a) Northlandia S 8 6 4 2 0 Interest rate 12% 10 8 6 4 D 100 200 300 400 500 600 700 800 900 1,000 Quantity of loanable funds (b) Southlandia S D 2 0 100 200 300 400 500 600 700 800 900 1,000 Quantity of loanable funds