Final answer:
The open-economy IS curve can be derived by analyzing the demand and supply for financial capital in a market with foreign investment. A diagram depicting the initial equilibrium with the supply including foreign capital shows how foreign investments impact interest rates and the quantity of investment, which in turn shifts the IS curve.
Step-by-step explanation:
The derivation of an open-economy IS curve can be illustrated by beginning with the analysis of the demand and supply for financial capital, particularly in a scenario where foreign investors are investing in a country's economy. A diagram can be drawn with the demand curve (D) representing domestic borrowers and a supply curve (S) that includes both domestic savings and incoming foreign investment. Initially, an equilibrium (Eo) exists where the interest rate (Ro) and the quantity of financial investment (Qo) are determined by the intersection of D and S. Foreign investment effectively shifts the supply curve rightward, creating a new equilibrium with a lower interest rate and higher quantity of investment.
To further link this with the open-economy IS curve, we recognize that the investment schedule depends on the interest rate. As foreign capital inflows reduce interest rates, domestic investment increases, shifting the IS curve to the right. This demonstrates the interconnectedness of capital flows, interest rates, and the macroeconomic equilibrium in an open economy.