Question

Suppose, initially the Australian economy is at full employment (in other words the economy is at the potential GDP). Using AD-AS model, explain how would each of the following events affect the economy both in the immediate and in the long term.

1. a) A slowdown in China’s economic growth due to the sub-prime crisis in the US. (3.5 marks)

2. b) Union wage settlements push the wage rate up.

3. c) An increase in consumer confidence. (3.5 marks)

Answer 1

a) Australia exports more than 79 billion worth of goods to China. Slowdown in China's economic growth will reduce the amount of export Australia make to China which will reduce aggregate demand of Australia in short run and shift its demand curve to the left from D to D1.

Due to fall in aggregate demand, producer will reduce their aggregate supply of goods as fall in price reduce their profit level. It shift supply curve to its left in long run which raise price to its initial level and reduce output level further.

b) Rise in wage rate raise cost of producing good which thereby induce producers to produce less of the goods and shift supply curve to its left from S to S1 and cause price level to rise as well as output level to fall.

Consumers in long run will reduce their demand duce to increase in price and shift demand curve to shift leftward cause price level to fall to its initial level and reduce output level further.

c) Increase in consumer confidence will shift demand curve to its right as consumption increases cause price as well as output level to rise.

Producers will raise their supply of goods when price rises in short run cause supply curve to shift to ita right which reduce price to its initial level and raise output level further.