Question

The Long-run Impact of Import Tariff A country imposes a tariff on imports from abroad. How does this action change the long-run real exchange rate between the home and foreign currencies? How is the long-run nominal exchange rate affected? Will this import restriction necessarily improve the home country's trade balance in the long-run? Explain carefully

Answer 1

Tariffs on foreign goods are introduced to support domestic production and consumption. This practice is used to discourage foreign imports and support strengthening of domestic market. When domestic market is strong, the economic affects like recession, inflation will have enough buffer for these changes. By introducing tariff, the demand shifts away from foreign exports and toward domestic goods, in long run the home currency gets appreciation.

When the domestic market becomes strong, the demand for domestic goods increases which in turn increase demand for home currency. So in the long run home currency gets nominal appreciation as well.

Yes it will reduce trade balance. But looking at the cost of production of a good, it may be cheaper in some other country because of cheaper and easily available resources. With imposed tariff competition will get reduced because of reduced players from other countries and people will be left with few options to buy.