Question

In a small open economy with a floating exchange rate, if the government imposes a tariff on foreign goods, then in the new short-run equilibrium: a. imports will decrease while exports remain constant, leading to a rise in net exports. b. imports will decrease and exports will increase, leading to a rise in net exports. c. imports will decrease and exports will decrease by an equal amount. d. both imports and exports will remain unchanged.

Answer 1

The correct answer is C) imports will decrease and exports will decrease by an equal amount.

In a small open economy with a floating exchange rate, if the government imposes a tariff on foreign goods, then in the new short-run equilibrium: imports will decrease and exports will decrease by an equal amount.

In a floating exchange rate, the currency price of the nation is set by supply and demand. The forex market allows supply and demand to determine the currency exchange rate. The opposite of this situation is a controlled rate in countries where the federal government exert control to the currency.