Question

30. In a small open economy, if consumers shift their preference toward Japanese cars, then net exports: A) fall, and the real exchange rate falls. B) fall, but the real exchange rate remains unchanged. C) remain unchanged, but the real exchange rate falls. D) increase, and the real exchange rate remains unchanged.

Answer 1

Answer: Option (B) is correct.

Explanation:

Correct Option: B) fall, but the real exchange rate remains unchanged.

In a small open economy, if there is a shift in the preferences of the consumers towards the Japanese cars then it will reduce the net exports of a country.

We all know that if a country is small then it will not affect the world prices and hence, real exchange also remains unchanged.

Now, if a country's consumers demand increases for the Japanese cars or we can say that their preferences shift towards the Japanese cars then there will be more imports of Japanese cars.

Therefore, Balance of trade or net exports falls because imports is one of the component of net exports but the real exchange rate remains constant.