Question

For each of the following, explain the impact of each event on the aggregate demand (AD), short run aggregate supply (SRAS) and long run aggregate supply (LRAS) of Malaysia:

(i) It is announced that Malaysia has just entered into a recession.

(ii) The price of petroleum decreases by another 60%.

(iii) Political and social unrest in Indonesia have caused many foreign firms to relocate their business to Malaysia.

b) (i) State the endogenous and exogenous factors of economic growth.

(ii) Analyse how technological change affects productivity.

Answer 1

i. When Malaysia has entered into recession, then consumer and investor seniment in the economy will become negative. Negative sentiment in the economy will reduce the level of investment and consumption expenditure in the economy by investors and households. This reduction will reduce the level of aggregate demand in the economy. As the level of aggregate demand in the economy decreases, price level and Real GDP in the economy will decrease.

ii. Petroleum is used as an important factor of production in the production process of various firms. As the cost of input decreases, the total cost of production in the economy will also decrease and this will increase profits of the firms. This induces firms to increase their production level at each price level and thus short run aggregate supply curve will shift rightwards which reduces price level and increases the level of Real GDP in the economy.

iii. Relocation of business will reduce the number of firms operating in the economy. This will reduce the production capacity of the firms and as production capacity of the firms decreases, the potential GDP produced by the nation also decreases and this will lead to leftward shift of the Long Run aggregate supply curve of the firm.

b. i. Internal or endogenous growth factors in the economy includes capital investment, increase in the labor force of the economy, increase in the number of firms in the economy. These factors increases aggregate supply in the economy and thus lead to rightward shift of the aggregate supply curve in the economy.

On the other hand, external or exogenous growth factors include increase in the technological advancement in the economy which increases efficiency in the economy and thus increases aggregate supply. Increase in the savings rate also increases output produced in the economy and thus lead to economic growth of the economy.

iii. Technological growth and development in the economy increases the amount of output produced at each price level because it increases the production capacity of the economy. As producion capacity in the economy increases, the overall productivity increases and this lads to rightward shift of the short run aggregate supply curve in the economy.