Question

An open economy with a downward sloping ERU curve is at the long-run equilibrium. Suddenly, the elasticity of demand for the monopolistically competitive firm's output η increases from 6 to 11. At the same time, labor productivity λ decreases from 12 to Z. After this ___(a)____ supply shock, the economy will transition to a new medium run equilibrium characterized by ___(b)____ real exchange rate, ___(c)____ level of output, ___(d)____ real consumption wage, and a trade ___(e)____. (Hint: choose your answers among the following words: "positive", "negative", "appreciated", "depreciated", "unchanged", "higher", "lower", "surplus", "deficit")

Answer 1

An open economy with a downward sloping ERU curve is at the long-run equilibrium. Suddenly, the elasticity of demand for the monopolistically competitive firm's output η increases from 6 to 11. At the same time, labor productivity λ decreases from 12 to Z. After this negative supply shock, the economy will transition to a new medium run equilibrium characterized by depreciated real exchange rate, lower level of output, lower real consumption wage, and a trade deficit.

Labor Productity measures the hourly output of a country's economy. A decrease in labor productivity refers to a condition where one or more worker compeletly task, processes, production or saes inefficiently. As a result, a decrease the supply curve shifts to the left and this is the negative supply shock, the economy will move to a new equilibrium point and at this point of equilibrium the price level will rise and output will fall. If the country's price level is higher relative to other countries, making its good more expensive. This lead to a decrease in the demand for that currency and therefore a depreciation of that currency. If the country's price level is higher relative to other countries foreign goods demand will increases and people import goods from foreign, as a result, the trade deficit will exists.