Question

when a country imposes an import quota, its

A. net exports rise and its real exchange rate appreciates

B. net exports rise and its real exchange rate depreciates

C. net export fall and its real exchange rate depreciates

D. none of above is correct

Answer 1

The nominal exchange rate can be defined as the number of units of domestic currency that can purchase a unit of given foreign currency.

The Nominal Exchange rate is the ratio of the value of the currency of two countries.

So when a country imposes an import quota, then import quantity decreases in the domestic country. Hence supply of goods and services decreases, therefore aggregate supply curve shifts leftward, therefore domestic price level increases in the economy. Since import decreases and export remains same, therefore net export increases.

Real exchange rate= nominal exchange rate * foreign price/domestic price.

So with the increase in the domestic price level, the real exchange rate decreases. In other words, the real exchange rate depreciates.

Hence option B is the correct answer.