Question

Suppose the outcome of the US presidential election causes a stock market crash in China.

Using the model of aggregate demand and aggregate supply, identify the changes in GDP.

Answer 1

If we suppose that due to the outcome of the US Presidential election, the Stock markets crash in China, the reason for such a crash can be attributed to the expectation of the Chinese firms and organizations that the new US Government which would be in power after the elections, will not maintain the same trade relation with China as it had done before the elections. Moreover, the political relation between the two Giant Nations may deteriorate. All these factors will make the investors in to various stocks (which are connected between US and China) to withdraw their shares or money and thereby the stock market crash in China becomes impediment. Let us understand the effects of this crash of Stock market in China on the GDP of the United states through the aggregate Demand and Aggregate supply models.

                                    From the above diagram we can see that the Supply of goods and services between US and China is measured along the X axes and the Demand for the goods and services between US and China is measured along the Y axes. Here, SS curve represents the aggregate demand prevailing in the trade market between US and China before the results of the Presidential election, and DD represents the aggregate supply prevailing in the trade market between US and China before the results of the Presidential election. D2D2 represents the aggregate demand prevailing in the trade market between US and China after the results of the Presidential election and S2S2 represents the aggregate supply prevailing in the trade market between US and China after the results of the Presidential election.

                                   We can see from the above graph that when there is a stock market crash in China, the political relation between the two countries will deteriorate and therefore, the supply of goods between the two countries will be highly impacted. US may impose various tariffs on many of its imports from China and may also impose export duty on many of the exported goods to China. This will result in the Chinese firms not supplying enough goods and services to US due to the marge increase in tax. This will result in to the US firms not receiving adequate supply of raw materials from China, thus incurring huge loss of their productivity. Moreover, the Chinese firms will also experience less supply from the US firms, due to huge increase in the export duty. The US firms will now, not be able to export goods at lower prices, and hence the supply will decrease. This will lead to a huge pile up of goods in the local markets. This will reduce the demand for the goods in the market and the prices will come down sharply. This reduction in prices will lead to the US firms making extra normal losses, over the already reduced supply of raw materials. The Gross Domestic Product (GDP) measures the aggregate development of the country’s equilibrium development over a year time. Due to the loss incurred by the US firms, their profits would be minimal, and they will increase the prices of other commodities to level up their losses. This will make a tremendous negative impact on the overall GDP of the United States. The GDP will show a declining trend in the short run. However, in the longer run, if the new US Government takes adequate measures to revive the economy and make it self-sufficient, there is every possibility that the US economy will resurge and improve its GDP.