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Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985

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BuyFindarrow_forward

Brief Principles of Macroeconomics...

8th Edition
N. Gregory Mankiw
ISBN: 9781337091985
Textbook Problem

Suppose the United States decides to subsidize the export of U.S. agricultural products, but it does not increase taxes or decrease any other government spending to offset this expenditure. Using a three-panel diagram, show what happens to national saving, domestic investment, net capital outflow, the interest rate, the exchange rate, and the trade balance. Also explain in words how this U.S. policy affects the amount of imports, exports, and net exports.

To determine

The impact of export subsidy on the economy.

Explanation

When the value of the total imports of the economy is subtracted from the total value of exports of the economy, the value of the net exports of the economy can be obtained. When the total value of imports is higher than that of the exports, it is known as the trade deficit; when the total value of imports is lower than that of the exports, it is known as trade surplus.

When the government provides export subsidies to the export-oriented productions, it helps the producers to market their products at lower prices in the international market. Thus, the subsidy helps to increase the net exports at any given real exchange rate. When the net exports increases, it will increase the demand for the US dollars in the currency exchange market, which will shift the demand curve towards the right. When the demand for the dollars increases in the foreign currency exchange market, it will shift the demand curve towards the right. As a result, there will be a new equilibrium in the foreign currency exchange market higher than the previous level, which increases the real exchange rate in the market. This increase in the real exchange rate will increase the import demand of the economy, which will finally match the increased export demand of the economy. Therefore, the net exports and the trade deficit will retain their previous position without any change...

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