5. Income adjustment mechanism and the foreign repercussion effect Aa Aa Conside

Question

5. Income adjustment mechanism and the foreign repercussion effect Aa Aa Consider a world consisting of equal-sized economies, Canada and Australia, that are on a system of fixed exchange rates. Initially, both economies are in a current-account equilibrium. Suppose that, due to a change in consumer preferences, Canada autonomously increases imports from Australia. How does the foreign repercussion effect work to restore the current-account equilibrium? Check all that apply. As Australia's income decreases, both Australian imports and Canadian exports fall. Australia's income increases, which raises Australia's imports and Canadian exports. Australian income decreases, reducing Australian imports and Canada's exports.

Explanation / Answer

Exports from Australia will increase the Australian income. At a higher income import in Australia will increase and exports will increase from Canada.

The answer is "B", Australia's income increases, which raises Australia's imports and Canadian exports.

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