legislators often call for protectionist measures to preserve domestic employmen
ID: 1121823 • Letter: L
Question
legislators often call for protectionist measures to preserve domestic employment. The purpose of this question is to evaluate the wisdom of legislation passed by domestic legislators to reduce domestic imports.
a. assuming flexible exchange rates, and assuming a fixed price level, what are the effects of the import restrictions on domestic output, the real exchange rate, exports, imports, and net exports in the short run?
b. how is your answer to part a affected by allowing the domestic price level to adjust
Explanation / Answer
a. Assuming a flexible exchange rate and a fixed price level in the economy, import restrictions will have a series of impact on the domestic output, the real exchange rate, exports, imports, and net exports in the short run.
An import restriction would boost the level of production of domestic output. Due to import restrictions, the demand for the output in the domestic market would rise, hence to meet the growing demand, the level of domestic output would increase.
Real exchange rate is defined as price of foreign commodities in terms of domestic commodities. In case of import restrictions, the imports become dearer/expensive for the domestic country. since, the price level in the economy is assumed to be fixed, this would lead to an increase in the real exchange rate in the economy.
Due to import restrictions, the demand for output in the domestic market would increase, thus to meet the growing demand, the level of production and supply of the domestic output would increase. Once the domestic demand has been met, the surplus output produced in the domestic market would be exported.
Import restrictions would basically, lead to a reduction in the level of imports in the domestic market.
As discussed above, increase in level of exports and reduction in the level of imports would lead to a positive net export in the short run.
b. If the domestic price level is allowed to adjust, then due to import restrictions, the level of domestic output increases and the price level of the domestic output also increases. Due to rise in domestic price level, the real exchane rate would remain constant, since rise in price of foreign goods due to import restrictions would be offset by an equal increase in the price level of domestic output. The increase in level of exports as well as imports would be comparatively lower in case of a flexible domestic price level. Net exports would be positive.
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