Answer
Please see the graph.
The export subsidy will increase the amount of net exports. This will cause the demand curve for dollars in the foreign exchange market to shift to the right.
Work Step by Step
The increased exchange rate will increase the level of imports to match the level of exports that were generated by the export subsidy. Since the imports will increase to match the level of exports, the trade deficit and the net exports are not changed.
The cost of the subsidy, though, increases the deficit. Increasing the deficit will decrease public saving and shift the loanable funds supply to the left. In turn, this increases the interest rate, and the increased interest rate decreases domestic investment.
Additionally, the increased interest rate decreases the net capital outflow. In turn, this decreases the supply of dollars on the foreign exchange market. In turn, the imports increase and the exports decrease.
Overall, imports increase, exports could either increase or decrease, net exports fall, and the trade balance moves closer to a deficit.
