Question

Write a response to the following scenario. Remember to correctly label all your graphs! For example, what the x and y axis represent.

The COVID-19 pandemic and the US-China trade tension have caused a significant decrease in China's demand for US exports.

Use the AD/AS model to explain the likely short run impacts on U.S. GDP and the aggregate price level. What do you anticipate will happen to U.S. consumption expenditure and U.S. employment? Please explain your reasoning for each of your predictions and show graphically as appropriate.

Answer 1

Lower demand for US exports will decrease US net exports, which decreases US aggregate demand, shifting AD curve leftward. In short run, both price level and GDP will decrease. Lower GDP will decrease consumption and decrease employment.

In long run, lower price level increases aggregate supply, shifting AS curve rightward, intersecting new AD curve at further lower price level but initial GDP. Both consumption and employment returns to initial levels.

In following graph, price level (P) and GDP (Y) are depicted along vertical and horizontal axes, respectively. AD0, LRAS0 and SRAS0 are initial aggregate demand, long-run aggregate supply and short-run aggregate supply curves intersecting at point A with initial price level P0 and real GDP (potential GDP) Y0. Higher consumption shifts AD0 rightward, intersecting SRAS0 at point B with higher price level P1 and higher real GDP Y1 in short run. In long run, SRAS0 shifts right to SRAS1, intersecting AD1 at point C with further lower price level P2 and real GDP restored to Y0.