Protectionist trade policies, such as tariffs on manufactured imports, are very popular among developing countries that cannot yet compete on the world market. These tariffs protect developing nations from foreign competition until they can acquire comparative advantages at which point the tariffs can slowly be phased out.

From a theoretical point of view, using the model of a SOE, explain the effects of the removal of tariffs on the SOEs' trade and income. Consider the effects of tariff removal under both (A) flexible and (B) fixed exchange rate systems.

Question: Under a flexible exchange rate, how does the removal of tariffs on imports impact the exchange rate, trade, and real GDP? Carefully explain the sequence of events. Support your answer with an IS*/LM* graph.

[Hint: Does the policy create rSOE> or < r*, NCO or NCI? What are the changes in e, NX and Y?]