In a small open economy, starting from a position of balanced trade, if the government increases the income tax, this produces a tendency toward a trade ______ and ______ net capital outflow.
A) deficit; negative
B) surplus; positive
C) deficit; positive
D) surplus; negative

Question

Quizplus · Accepted Answer

When the government increases the income tax, it generally reduces consumers' disposable income, leading to a decrease in consumption, including the consumption of imported goods. This reduction in imports, all else being equal, can lead to a trade surplus. Additionally, with lower domestic consumption and investment, there may be less demand for foreign capital, leading to a positive net capital outflow as the country lends more abroad.

In a Small Open Economy, Starting from a Position of Balanced