Question

Use the long run model for a small open economy to determine the expected effect on
the equilibrium from a decrease in taxes (T).
For each of the following variables, state whether it is expected to increase (+), decrease
(–), remain unchanged (0), or whether the effect is indeterminate (?). Explain your answers.
All variables are in real terms.
(a) national savings (S)
(b) net exports (NX )
(c) the real exchange rate (ε)

Answer 1

when there is a decrease in taxes (t) then it will lead to increase in real interest rates and also affect the other macroeconomic variables in the economy  in the following manner:-

a)national savings :- it directly depends on real rate of interest since with decrease taxes there will be positive impact on the income with people so will raise the national savings also . so national savings will increase (+).

b)net exports (nx):- since decrease in taxes will raise rate of interest so will international rate of interest will also increase so this put a negative impact on net exports. so there will be decrease(-) in net exports.

c)real exchange rate:- it also have impacts with rise in real interest rates so will real exchange will increase (+).