Ing the DD-AA model, analyze the output and balance of payments effects of an import tariff under fixed exchange rates. What would happen if all countries in the world simultaneously tried to improve employment and the balance of payments by imposing tariffs?

An import tariffs will make imports costly and force the domestic consumers to reduce consumption of imported goods, and increased the consumption of domestically produced goods

With an increased output the DD-AA model  increases the money demand and thus shifts the DD curve towards the right, which therefore decreases the exchange rate; which implies currency appreciation.

If all countries retaliate to imposition of an import tariffs by the same, this will lead to a conflicting situation.

Explanation:

Solution

Government task on imported goods design either to raise revenue or protect domestic industries from foreign competition is called import tariffs.

An import tariffs will make imports costly and force the domestic consumers to reduce consumption of imported goods, and increased the consumption of domestically produced goods. for this domestic output increases.

The DD-AA model, an increased output increases the money demand and thus shifts the DD curve towards the right, which therefore reduces the exchange rate; which implies an appreciation of the currency.

Under fixed exchange rate a deviation in exchange rate is responded by central bank intervention in the foreign market.

the central bank must buy foreign assets with money, thereby increasing the money supply which corresponds to a balance surplus. the money expansion in the economy shifts AA curve towards the right.

As a result of this, the economy regains original equilibrium with higher output and higher official international reserve but at the initial rate of exchange.

Note: Kindly find an attached copy of part of the solution to this question below.

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