In a small open economy, starting from a position of balanced trade, if the government increases domestic government purchases, this produces a tendency toward a trade ______ and ______ net capital outflow.
A) deficit; negative
B) surplus; positive
C) deficit; positive
D) surplus; negative

Question

Quizplus · Accepted Answer

In a small open economy, an increase in domestic government purchases, with no change in taxes, leads to a rise in interest rates. This attracts foreign capital, appreciates the currency, and makes exports more expensive while imports become cheaper. As a result, exports decrease, imports increase, leading to a trade deficit. The capital inflow required to finance this deficit is positive, but since the question asks about net capital outflow, the correct terminology in the context of the question's phrasing would be "negative" net capital outflow, reflecting the inward flow of capital to finance the deficit.

In a Small Open Economy, Starting from a Position of Balanced