Draw an AS/AD diagram to illustrate a decrease in dollar value in the US economy ....

Draw an AS/AD diagram to illustrate a decrease in dollar value in the US economy . Clearly label axes and the current position of AS & AD relative to full employment RGDP....also indicate any shifts that would occur if the exchange rate of the $ rose sharply against other major currencies

Expert Solution

In each of the following graphs, initial full-employment equilibrium is at point A where AD0 (aggregate demand), LRAS0 (long-run aggregate supply) and SRAS0 (short-run aggregate supply) curves intersect with initial equilibrium price level P0 and initial equilibrium real GDP (= potential GDP) Y0.

(I) Decrease in dollar

A dollar depreciation will increase US exports and decrease US imports, so net exports will increase, which increases aggregate demand. AD curve shifts rightward and increases both price level and real GDP. A recessionary gap arises.

In following graph, AD0 shifts leftward to AD1, intersecting SRAS0 at point B with lower price level P1 and lower real GDP Y1. Recessionary gap is (Y0 - Y1).

(II) Increase in dollar

A dollar appreciation will increase US imports and decrease US exports, so net exports will decrease, which decreases aggregate demand. AD curve shifts leftward and decreases both price level and real GDP. An inflationary gap arises.

In following graph, AD0 shifts rightward to AD1, intersecting SRAS0 at point B with higher price level P1 and higher real GDP Y1. Inflationary gap is (Y1 - Y0).

Rahul Sunny answered 2 years ago

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