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. i. There is a sharp fall in Canada’s exchange rate ii. A wave of pro-Canadian sentiment sweeps the U.S. and people in U.S. increase their consumption of Canadian goods iii. There is a recession in China, which is a large importer of Canadian agricultural goods iv. Due to a global health concern, there is a travel restriction of foreign travelers coming to Canada

Answer 1

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

a) Due to fall in Canada's exchange rate means domestic currency is worth less to other currencies or foreign currency can buy more of domestic currency which will make domestic goods comparatively cheaper for foreign customers. It will raise exports from Canada and reduce imports which tends to raise aggregate demand of Canada and shift aggregate demand curve to its right from AD to AD1 which will raise price level from P to P1 and raise output from Y to Y1.

b) If people in U.S. increased consumption of Canadian goods which will raise exports of Canadian goods and raise aggregate demand of Canada which tends to raise aggregate demand of Canada and shift aggregate demand curve to its right from AD to AD1 which will raise price level from P to P1 and raise output from Y to Y1.

c) There is recession in China which is a large importer of Canadian goods which means Canada will not be able to export their goods which will reduce their aggregate demand and shift aggregate demand curve to its left from AD to AD1 which tends to reduce price level from P to P1 and reduce output level from Y to Y1.

d) Due to travel restriction of foreign travellers coming to Canada which will reduce aggregate demand of Canada because of fall in demand of hotels, tourist sites and travellers shopping goods from Canada. It will shift aggregate demand curve to its left from AD to AD1 which tends to reduce price level from P to P1 and reduce output level from Y to Y1.