Question

President Trump has made tariffs a central part of his trade policy.

(a) Please sketch a graph that shows how trade tariffs affect Net Exports and the exchange rate.

(b) What are two alternative policies that the President and congress could use to reduce the trade deficit?

Answer 1

If Trump has made tariffs a central part of his trade policy:

a) Due to tariff imposed, U.S. consumers would find it cheaper to purchase imported products which would reduce the demand of products from abroad. Imports in U.S. would fall while there is no direct effect on Exports in short run. As Net exports is Exports - imports, fall in Imports would raise the Net Exports.

AD = C + I + G + Net Exports

As Net exports have increased aggregate demand in the economy would rise.

As there is constant Savings - Investment level in the economy, rising Net exports would raise the real exchange rate from R to R1 in the country.

b) If Trump wants to reduce the trade deficits, they can adopt:

• Apply Protectionism policy which reduces the demand for foreign based products and raise the domestic demand.
• Reduce imports from China as major chunk of Imports come from China which raises the trade deficits.