Jamaica is a small open economy that has a trade surplus. Use savings/investment

Question

Jamaica is a small open economy that has a trade surplus. Use savings/investment diagrams to answer the following:

a) Suppose the Government of Jamaica decides to raise taxes. How will the equilibrium amount of savings, investment, and trade balance be affected?

b) Suppose that scenario a) above never happened. Consider instead the case where the US, a large open economy and Jamaica's largest trading partner, had passed a tax increase. How would Jamaica's equilibrium savings, investment, and trade balance be affected? Use one S-I diagram for the US, and another one for Jamaica. How is Jamaica's currency affected? Please explain

Explanation / Answer

A) Government of jamica raises taxes then it will have lower savings, lower investment and trade balance will be negatively effected. It will also cause negative effect on competitiveness and cause inflation.

B) Now its largest trading partner raises taxes, this will have negative impact on jamica's exports as americans would likely spend less on goods and services.

Jamica's savings would not change much

Jamica's investment will decrease as demand from its partner decreases

trade balance would be negatively impacted results in trade deficit.

Jamica's currency would be negatively impacted as lower exports lead to lower currency reserves.

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