Under flexible exchange rates, if the domestic currency depreciates, net exports will most likely
A)increase in both the short run and the long run
B)decrease in both the short run and the long run
C)increase in the short run but decrease in the long run
D)decrease in the short run but increase in the long run
E)increase in the short run, but remain unchanged in the long run

Question

Quizplus · Accepted Answer

Under flexible exchange rates, a depreciation of the domestic currency would make exports cheaper and imports more expensive, making domestic goods more attractive to foreign buyers and foreign goods less attractive to domestic buyers. This would result in an increase in net exports in the short run. However, in the long run, the increase in net exports would attract foreign investment, which would increase demand for domestic currency, leading to appreciation of the currency. This, in turn, would make exports more expensive and imports cheaper, reducing net exports back to their original level or even lower than before. Therefore, net exports would decrease in the long run.

Under Flexible Exchange Rates, If the Domestic Currency Depreciates, Net