Question

Country C is a farming country. Country C imports fertilizers from other countries. Price of fertilizers increases temporarily. Answer each of the following parts.

1. Draw an AD-AS graph to show the long-run equilibrium before the increase in price of fertilizers.
2. On your graph for part (a), show what happens to AD, SRAS and LRAS in short run.
3. In short run after the increase in the price of fertilizers, does the unemployment rate increase? Does the real GDP increase?
4. Does the full-employment output increase, decrease or remain the same? Does the natural rate of unemployment increase, decrease or remain the same? Explain briefly.

Answer 1

A. The equilibrium before rising of prices is given as

B. With a rise in prices(P1- P2) of fertilizer, the aggregate supply is seen to be shifting to the left. This is because with the rising prices, the supplied quantity reduces as the quantity of fertilizer being demanded is falling.

With a constant falling supply , in the long run, with increased prices, the long run aggregate supply curve also shifts to the left.

This is shown in the attached diagram.

C. Yes the unemployment rate tends to rise with the rising prices , as now , with the GDP rate falling due to rising prices, the economy cannot uphold the earlier level of employment . The fall of real wages will also cause the labours to leave the job .

D. The full employment output tends to fall. This is because with rising prices of fertilizers , the output tends to fall , as it becomes costlier to produce the same output.

The natural rate of unemployment tends to rise because the general rate of output production in the long run declines ( with long run aggregate supply shifting leftward). Hence this shifts the demand for labours to falls , causing natural rate of unemployment to rise.