Question

In 2018 the United States and China entered into a trade dispute that led both countries to impose tariffs on each other’s goods. Economists concluded that the tariffs contributed to slower growth in real GDP for both countries, though the effects were greater in China. Using aggregate demand and supply analysis explain and graph how a trade surplus can lead to a slowing real GDP in both countries.

Answer 1

When US levied a series of tariffs on Chinese imports, the Chinese economy suffered a huge blow as the US market provided a major consumer base for its exports. As a result of the trade war, US consumers now pay a higher price for goods and services it used to buy for cheap as a result of Chinese dumping policies.

In the above diagram, we show the macro scenario of the Chinese economy.

• Initially, the economy is in equilibrium at E₀, corresponding to (P₀, Y₀).
• After the tariff is levied on Chinese Exports, export demand for Chinese economy shrinked.
• This directly results in the decline of NX component of AD.
• As a result of which, the AD shifts from (AD)₀ to (AD)_1.
• _­The output and price in the Chinese economy both declined at the new equilibrium (E₁), resulting in slower output (real GDP) growth.

In the above diagram, we show the macro scenario of the US economy.

• Initially, the economy is in equilibrium at F₀, corresponding to (P₀, Y₀).
• After the tariff is levied by the US administration, cheap Chinese imports into the country declines.
• Thus, the average US consumer now has a fewer alternatives to choose from, while buying goods and services.
• As a result of which, the AS of the US economy decreases at each level of quantity and hence shifts to the left, from (AS)₀ to (AS)_1.
• _­The output in the US economy declined and price increased at the new equilibrium (F₁), resulting in slower output (real GDP) growth, and painful inflation for the US economy.