Page 673 - The Principle of Economics

CHAPTER 30
A MACROECONOMIC THEORY OF THE OPEN ECONOMY 691
(a) The Market for Loanable Funds
(b) Net Foreign Investment
Supply
Demand
NFI
3. Net exports, however, remain the same.
Real Interest Rate
r1
Real Interest Rate
r1
Real Exchange Rate
E2 E1
Quantity of Loanable Funds
Net Foreign Investment
Supply
1. An import quota increases the demand for dollars . . .
D2 D1
(c) The Market for Foreign-Currency Exchange
Quantity of Dollars
THE EFFECTS OF AN IMPORT QUOTA. When the U.S. government imposes a quota on the import of Japanese cars, nothing happens in the market for loanable funds in panel (a) or to net foreign investment in panel (b). The only effect is a rise in net exports (exports minus imports) for any given real exchange rate. As a result, the demand for dollars in the market for foreign-currency exchange rises, as shown by the shift from D1 to D2 in panel (c). This increase in the demand for dollars causes the value of the dollar to appreciate from E1 to E2. This appreciation of the dollar tends to reduce net exports, offsetting the direct effect of the import quota on the trade balance.
due to the import quota. In the end, an import quota reduces both imports and exports, but net exports (exports minus imports) are unchanged.
We have thus come to a surprising implication: Trade policies do not affect the trade balance. That is, policies that directly influence exports or imports do not alter
2. . . . and causes the real exchange rate to appreciate.
Figure 30-6