Question

Analyze the short-run effects on the Canadian economy of each of the following events using aggregate expenditure (AE) and aggregate demand and supply (AD-AS) diagrams. In each case, identify the cause of any shift or movement along AE, AD, and/or AS and note the effect on national income (Y) and the price level (P).

(a) A change in tastes leads Canadian consumers to transfer their video spending from domestic cable TV services to domestic video streaming services.

(b) In response to the tax reform package recently passed in the US, the Canadian government reduces domestic tax rates.

(c) As a result of the collapse of the NAFTA renegotiation, Canadian exports are reduced.

(d) An increase in wages leads to an increase in unit costs for Canadian producers.

Answer 1

(a) When Canadian consumers shifts from domestic cable TV services to domestic video streaming services, aggregate expenditure will be increased. As aggregate demand changes due to third factors, and not by changes its own price so there will be a shift of AE and AD. AE1 shifts to AE2 and the aggregate demand shifts from AD1 to AD2. national income increase from Y1 to Y2. Price level will be increased from P1 to P2.

b) Disposable income will be increased after reduction of domestic tax. So aggregate expenditure, aggregate demand will be increased. As a result price and national income will be increased. Here demand is increased due to increase in income so AD AE curve will be shifted to the right.

c) When exports are reduced, income will be decreased. As a result, aggregate expenditure and aggregate demand will be decreased. National income and price level will be decreased. This changes due to the reduction of export, not by changes in own price so AE and AD curve will be shifted.

d) An increase in the wage increases cost of production. expenditure will be decrease and aggregate supply will be decreased. As supply is decreased due to the cost of production so there will be a shift of the aggregate supply curve and AE curve. As a result, national income and price will be reduced.