The substitution (trade-effect) shows that:
A) an increase in the domestic price level will make domestic goods more expensive relative to foreign goods. As a result, people would buy less domestic goods and buy more foreign goods.
B) a lower price level will decrease the real value of many financial assets and therefore reduce net export spending.
C) a higher price level will increase the real value of many financial assets and therefore increase net export spending.
D) an increase in the price level in foreign economies will also make domestic goods more expensive relative to foreign goods. As a result, people would buy less domestic goods and buy more foreign goods

Question

Quizplus · Accepted Answer

The substitution effect, in the context of international trade, implies that when domestic prices increase, domestic goods become relatively more expensive compared to foreign goods. This leads consumers to substitute domestic goods with cheaper foreign alternatives, thus reducing the consumption of domestic goods in favor of foreign goods. Choices B and C describe the wealth effect, not the substitution effect, and D incorrectly states the impact of foreign price level changes on the relative expense of domestic goods.

The Substitution (Trade-Effect) Shows That