Exam 5: The Open Economy

The government of a small open economy wishes to promote trade policies that will result in currency appreciation. a.Would protectionist policies (higher tariffs and more quotas)or freer trade policies (tariff reductions and quota eliminations)be more effective in generating currency appreciation? b.Using the basic version of the long-run exchange-rate model to illustrate graphically the impact of the trade policy on the exchange rate of the small open economy. c.What will happen to the trade balance of the small open economy as a result of the trade policies,assuming that the country started from a position of free trade? d.What will happen to the quantity of exports and imports as a result of the trade policies?

An appreciation of the real exchange rate in the basic model of a small open economy could be the result of:

In an open economy:

If the purchasing-power parity theory is true,then: