Question

Explain, using the AD/AS framework and with the aid of a graph, how a trade war with the US will impact on China’s GDP.

DO NOT USE SAME ANSWER AS JUST POSTED WITH A CLEAR GRAPH!! :)

Answer 1

A trade war with US will cause US impose trade restrictions on China's exportable goods which are imported in US. As a result, US import demand falls and China's export demand falls, lowering China's net exports. This decreases Chinese aggregate demand. AD curve will shift to left, decreasing price level and decreasing real GDP, leading to short run recessionary gap. In the long run, lower price level decreases production cost, hence firms raise production, increasing aggregate supply. SRAS shifts rightward, intersecting new AD curve at further lower price level but restoring original real GDP and eliminating the short run recessionary gap.

In following graph, initial long-run equilibrium is at point A where AD0 (aggregate demand), LRAS0 (long-run aggregate supply) and SRAS0 (short-run aggregate supply) curves intersect, with initial long-run equilibrium price level P0 and initial equilibrium real GDP (equal to full employment GDP) Y0. When China's net exports falls, AD curve will shift leftward from AD0 to AD1, intersecting SRAS0 at point B with lower price level P1 and lower real GDP Y1, with recessionary gap of (Y0 - Y1) in short run. In long run, SRAS0 shifts right to SRAS1, intersecting AD1 at point C with further lower price level P2 and restoring real GDP to potential GDP level Y0, eliminating the recessionary gap.