Consider the relationship between the exchange rate and the balance of payments. Examine the case of a small country in the import and export markets under the elasticity approach.

(a)Draw a separate graph for the import market and the export market illustrating the effect of a rise in e, on the foreign price of imports and exports and the quantities of imports and exports respectively.

(b)What can be determined about the effect on the trade balance from a rise in e as a result of your analysis in part (a).

(1 mark)

(c)If there is less than 100% pass through how might this impact on import expenditure?

(d)Assume a small economy is below full employment. Illustrate and explain how a reduction in the value of the domestic currency (rise in e) will impact on the trade balance under the absorption approach.

(e)Consider how you might model the impact of the COVID19 virus on a small economy initially at full employment. Discuss likely outcomes using the absorption model.