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 exports will both rise.

Question

Quizplus · Accepted Answer

If large foreign countries institute an investment tax credit, it will increase investment in those countries, which will increase their demand for their own currency. This will cause their currency to appreciate relative to other currencies, including the currency of the small country. As a result, the real exchange rate of the small country will fall, making its exports cheaper and more competitive. This will lead to an increase in net exports.

Assume That Some Large Foreign Countries Decide to Subsidize Investment