Question

The country imposes a tariff on foreign-produced goods. (For simplicity, suppose that the effect of the tariff is the following: at every value of the real exchange rate, the demand for domestic goods is higher and the demand for foreign goods is lower.) You might find it surprising that the equilibrium trade balance doesn’t change in this example; briefly give some intuition for why the Classical Small Open Economy Model implies this result.

Answer 1

It is said that the country imposes a tariff on the foreign produced goods due to this implementation of tariff the demand for the domestic goods is also high, as a result the exports demand rises. Due to this effect the real exchange rate rises from E1 to E2 and the equilibrium point increased from point one to another.