Question

Imagine that the United States puts in place a 45 percent tax on imports. What is the long-run impact of this tax (an import tariff) on the value of the U.S. dollar, on U.S. net exports, and U.S. GDP. Explain.

Answer 1

If the United States puts in place 45 percent tax on imports then in the long run the price of imports in US in will increase by 45 percent which will turn induce people of United States to decrease their demand for foreign goods due higher prices and as a result of which demand for foreign currency by United States will decreases which will in turn decrease the exchange rate, in other words the US dollar will appreciate against foreign currencies in the long run.

And as the dollar appreciates it makes exports from United states expensive for foreign countries since now they will have to pay higher price for the same amount of dollars. So foreign countries will react to this by decreasing their demand for US goods and services which would mean for United states that its exports of goods and services will decline on account of lower currency appreciation.

Now what effect this will have GDP of United States? United States many inputs from foreign countries so an increase in import tariff by 45 percent would mean that the cost of inputs for US manufacturers will increase which will be reflected in the higher price of manufactured goods. And higher price level will lead to lower aggregate demand in the US economy, and consequently lower GDP. Adding to this, the decrease in export demand will also contribute to lower GDP of US.

So the effect of increase in import tariff to 45 percent, is that imports will be reduced which will result in appreciation of US dollar or in other words value of US dollar will increase. The exports will decline and the GDP will also decline.