Question

Using the AD AS model, explain what will happen to the price level and real GDP if either the SRAS or AD curve shifts. You are told that 2 events take place and you must explain which curve shifts and in what direction.

Answer 1

Event 1

Country X seals its borders and cancels all trade and exchange deals with Country Y due to a national security threat.

X is a labour abundant country and Y is relatively capital abundant. X used to import raw materials from Y because of the cost advantage but now it will have to produce those raw materials within the country and that will raise the cost of production. As a result the short run aggregate supply curve will shift to the left and thus price level will rise and there will be contraction on the AD curve and real GDP will fall.

Event 2

Due to the Corona pandemic,as is in all countries, Country A saw a drastic fall in Consumption expenditures due to social distancing, loss of jobs and confinement to purchase and usage of necessities only. As a result the AD curve will shift to the left leading to a fall in price levels Leading and to contraction along the AS curve and thus ultimately real GDP will also decline.