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Using an appropriate diagram, explain the effects on the exchange rate (e) of an increase in...

Using an appropriate diagram, explain the effects on the exchange rate (e) of an increase in foreign Lump Sum Taxes. Explain what happens to the value of the dollar. Explain what happens to NX.

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Ans. Increase in level of taxes in foreign country decreases the return on investment in foreign country, so, it makes investment in foreign country less attractive increasing net capital outflow from foreign country which decreases the demand for its currency leading to depreciation of its currency or appreciation of our home currency. This appreciation makes exports expensive, decreasing their demand and make imports cheaper, increasing their demand. This leads to a decrease in net exports of home country.

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