The assumption of a small open economy is sometimes partial at best to describe the behavior of some economies, that although they remain small with respect to the "rest of the world"; they face an elastic demand curve for some of their goods and services by their neighbors. This type of integration is due to transport costs and barriers to international trade and capital flows. This restrictions that are binding with the rest of the world are easily lifted among neighboring countries through preferential trade agreements or by smuggling. The purpose of these paper is to find the impact of changes in the exchange rate gap of a neighbor country in a small open economy that faces two "rest of the world ". For this purpose we extend the traditional income-expenditures model to include a foreign demand for the domestic good. After we derive the real and monetary effects of this shock we describe the alternative policies under different type of restrictions.
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Article provided by Instituto de Economía. Pontificia Universidad Católica de Chile. in its journal Cuadernos de Economía.
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