In a small open economy a decrease in the exchange rate will _____ net exports and shift the _____ curve.
A) increase; IS
B) decrease; IS
C) increase; LM
D) decrease; LM

Question

Quizplus · Accepted Answer

A decrease in exchange rate means that the currency of the small open economy is now cheaper compared to other currencies. This makes exports cheaper for foreign buyers and imports become relatively more expensive for domestic buyers. As a result, net exports will increase as foreign buyers increase their demand for domestically produced goods and domestic buyers decrease their demand for foreign-produced goods.

An increase in net exports will shift the IS curve to the right because it will increase output and income. This is because an increase in net exports will lead to an increase in aggregate demand, which in turn leads to an increase in output and income.

In a Small Open Economy a Decrease in the Exchange