Question

Assume that Canada is initially in long run equilibrium with price level of P1 and GDP of Y1. Discuss how each of the following four events would affect aggregate demand, the price level and real GDP of Canada (mentioning how net exports are impacted)

a. There is a sharp fall in Canada’s exchange rate

b. A wave of pro-Canadian sentiment sweeps the U.S. and people in U.S. increase their consumption of Canadian goods

c. There is a recession in China, which is a large importer of Canadian agricultural goods

d. Due to a global health concern, there is a travel restriction of foreign travellers coming to Canada

Answer 1

a) Fall or depreciation of exchange rate will make imports costlier and exports cheaper because more of a dollar is needed to buy the same foreign currency now.

Aggregate demand = Consumption + Investment + Government spending + Exports - Imports

Rise in exports and fall in imports will raise aggregate demand in an economy which will shift demand curve to its right from AD to AD1. It will result in rise in price level and output level.

b) There is rise in demand of canadian goods by U.S. consumers which means there is rise in exports of Canadian goods which will raise aggregate demand.

Aggregate demand = Consumption + Investment + Government spending + Exports - Imports

Rise in exports will raise aggregate demand in an economy which will shift demand curve to its right from AD to AD1. It will result in rise in price level and output level.

c) Recession in China will reduce imports of Canadian goods which is exports for Canada. Fall in exports will reduce aggregate demand and shift demand curve to its left from AD to AD1 which will reduce price as well as output level.

d) As there is restriction of foreign traveller coming to Canada, there would be decline in aggregate demand of Canadian goods because travellers shop when they go to other countries. Fall in aggregate demand will shift demand curve to its left from AD to AD1 which will reduce price as well as output level.