Attempts: Keep the Highest: /3 5. Income adjustment mechanism and the foreign re
ID: 1109869 • Letter: A
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Attempts: Keep the Highest: /3 5. Income adjustment mechanism and the foreign repercussion effect Aa Aa Consider a world consisting of equal-sized economies, Germany and Mexico, that are on a system of fixed exchange rates. Initially, both economies are in a current-account equilibrium. Suppose that, due to a change in consumer preferences, Germany autonomously increases imports from Mexico. How does the foreign repercussion effect work to restore the current-account equilibrium? Check all that apply. German income increases as imports are substituted for home-produced goods, which, in turn, increases its imports. German income decreases as imports are substituted for home-produced goods, which, in turn, reduces its imports. The rise in Mexico's income induces an increase in exports from Germany. QNA 3.16 © 2004-2016 Aplia. All rights reserved. © 2013 Cengage Learning except as noted. All rights reserved. Grade It Now Save & ContinueExplanation / Answer
Foreign repercussion effect states that ‘it is a situation where a change in one nations macroeconomic variable , which is related to another nation , creates a chain reaction in economies of both the nations.’
Current account equilibrium is a position where a nations imports and exports are balanced .
If Germany autonomously increases imports from Mexico , Germany’s current account will go into deficit ,as imports from Mexico have been increased.
To restore the current account balance , foreign repercussion effect comes into place .
If Germany increases imports from Mexico , income of Mexico increases , and as income increases , there will be a proportionate increase in exports from mexico .
Another effect that takes place due to foreign repercussion effect is that as income of Germany decreases ( due to increase in imports ) , Germany will reduce its imports as imported goods are available easily and are substituted for home produced goods.
Therefore options 2 and 3 apply .
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