The introduction of a stylish new line of Toyotas, which makes some consumers prefer foreign cars over domestic cars, will, according to the Mundell-Fleming model with fixed exchange rates, lead to:
A) a fall in income and net exports.
B) no change in income or net exports.
C) a fall in income but no change in net exports.
D) no change in income but a fall in net exports.

Question

Quizplus · Accepted Answer

Under the Mundell-Fleming model with fixed exchange rates, an increase in demand for foreign goods (in this case, Toyotas) leads to an outflow of currency to purchase these goods. This results in a decrease in the domestic money supply (assuming the central bank does not intervene), which can lead to higher interest rates and a decrease in investment and consumption, ultimately causing a fall in income. Additionally, since more foreign goods are being imported, net exports will decrease.

The Introduction of a Stylish New Line of Toyotas, Which