Assume that some large foreign countries decide to subsidize investment by instituting an investment tax credit. Then a small country's real exchange rate:
A)will fall, and its net exports will rise.
B)will rise, and its net exports will fall.
C)and net exports will both fall.
D)and net exports will both rise.

Question

Quizplus · Accepted Answer

The investment tax credit will make investment in the foreign countries more attractive, leading to a higher demand for their currency. This will cause the foreign currency to appreciate against the small country's currency, leading to a fall in the small country's real exchange rate. The fall in the real exchange rate will make the small country's exports cheaper and its imports more expensive, leading to a rise in net exports.

Assume That Some Large Foreign Countries Decide to Subsidize Investment