Protectionist policies in a small open economy do not alter the trade balance because the:
A) quantity of imports and exports is fixed.
B) interest rate adjusts to offset any reductions in imports.
C) exchange rate appreciates to offset the increase in net exports.
D) level of net capital outflow is fixed by the world interest rate.

Question

Quizplus · Accepted Answer

In a small open economy, protectionist policies do not have any significant impact on the trade balance because the level of imports and exports is largely determined by global market forces. Therefore, if a country imposes protectionist policies such as tariffs or quotas, it may temporarily reduce the quantity of imports but this would be offset by an increase in the exchange rate, which would make exports more expensive and less competitive. As a result, the trade balance remains largely unchanged. However, an increase in net exports would cause the exchange rate to appreciate and this appreciation would in turn reduce the level of net exports until the trade balance is back to its initial level.

Protectionist Policies in a Small Open Economy Do Not Alter