In September 1995, Patrick Buchanan, a Republican candidate for U.S. president,

Question

In September 1995, Patrick Buchanan, a Republican candidate for U.S. president, proposed a 10 percent tariff on Japanese imports to the United States, a 20 percent tariff on Chinese imports to the United States, and an unspecified “social” tariff on imports from third-world countries. a. Use the long-run model of a small open economy to illustrate graphically the impact of these trade policies on the U.S. exchange rate and the trade balance. Assume that the country starts from a position of trade balance, i.e., exports equal imports. Be sure to label: i. the axes ii. the curves iii. the initial equilibrium values iv. the direction the curves shift v. the new long-run equilibrium values. b. Based on your graphical analysis, explain the predicted impact of Mr. Buchanan's proposed policies. Specifically state what happens to the exchange rate, the trade balance, the volume of imports, and the volume of exports.

Explanation / Answer

a)

As a result of the tariffs, the US real exchange rate will rise and exports will remain unchanged.

b)

Under his policy, the dollar would appreciate, though trade balance would remain unchanged. The imports would decrease because of the high tariffs and exports would decrease by almost same amount because of currency appreciation.

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