In a large open economy, if an import quota is adopted, then:
A) net exports remain unchanged, as imports and exports decrease by equal amounts, while the real exchange rate rises.
B) net exports remain unchanged, as imports and exports decrease by equal amounts, while the real exchange rate falls.
C) net exports rise and the real exchange rate rises.
D) net exports rise and the real exchange rate falls.

Question

Quizplus · Accepted Answer

An import quota restricts the amount of imports allowed into the country. This leads to a decrease in the supply of imported goods, causing their prices to rise. This increase in the relative price of imported goods leads to a decrease in demand for them, causing imports to fall. Since exports are not affected by the import quota, net exports remain unchanged. However, the rise in the relative price of imported goods leads to an increase in the real exchange rate, making imports more expensive and exports cheaper. Therefore, the correct answer is A) net exports remain unchanged, as imports and exports decrease by equal amounts, while the real exchange rate rises.

In a Large Open Economy, If an Import Quota Is