The country imposes tariffs on imports. This would cause its currency to:

Question

BlackTom AI · Accepted Answer

Tariffs reduce import demand and tend to improve the trade balance, so the domestic currency will appreciate in the long run.

1) Relevant knowledge points and concepts
- Balance of payments: the current account includes net exports (exports − imports); a reduction in imports improves the current account all else equal.
- Foreign-exchange market: importers demand foreign currency to pay for imports; exporters supply foreign currency when selling abroad. Changes in import demand change net demand for foreign currency and thus the domestic currency's exchange rate.
- Short-run vs. long-run adjustment: prices, contracts, and capital flows may delay or alter immediate exchange-rate responses relative to longer-run fundamentals.

2) Step-by-step reasoning
Step 1: A tariff raises the effective price of imported goods for domestic consumers.
Step 2: Higher import prices reduce the quantity of imports demanded (substitution to domestic goods and reduced consumption).
Step 3: With fewer imports, domestic residents need to buy less foreign currency to pay for those imports — demand for foreign currency falls.
Step 4: Lower demand for foreign currency translates into relatively higher demand for domestic currency in the foreign-exchange market, placing upward pressure on the domestic currency’s value (appreciation).
Step 5: Over the long run, as trade flows adjust, the improved current account supports a stronger currency compared with the no-tariff baseline.

3) Calculations
- No numerical calculation is necessary; the logic is qualitative market demand-supply.

4) Why the correct answer is correct
The correct answer (“appreciate in long run”) follows directly from reduced import demand lowering foreign-currency demand and improving the trade balance, which increases the value of the domestic currency over time.

5) Why other options are incorrect
- “Depreciate in long run”: contradicts the mechanism—reduced imports should reduce foreign-currency demand, not increase it.
- “Depreciate in short run”: while short-run movements can be noisy, the immediate expected effect from lower import demand is not systematic depreciation.
- “Appreciate in short run”: short-run responses may be muted or offset by portfolio flows and price rigidities; the textbook prediction is a long-run appreciation as trade balances adjust.

Conclusion: Therefore the domestic currency will appreciate in the long run, confirming the provided answer.

The country imposes tariffs on imports. This would cause its currency to:Single choice

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