In a small open economy with a fixed exchange rate, if the government imposes an import quota, then net exports:
A) decrease but the money supply falls and income falls.
B) increase, the money supply increases, and income increases.
C) are unchanged but the money supply falls and income falls.
D) are unchanged, the money supply is unchanged, and income is unchanged.

Question

Quizplus · Accepted Answer

Imposing an import quota in a small open economy with a fixed exchange rate reduces imports, which increases net exports. As net exports increase, the money supply in the economy also increases because the central bank must buy foreign currency to maintain the fixed exchange rate, injecting more domestic currency into the economy. This increase in the money supply boosts aggregate demand, leading to an increase in income.

In a Small Open Economy with a Fixed Exchange Rate