Question

How does a recession in Asia affect U.S. aggregate demand and the U.S. aggregate demand curve? What has happened to (i) real GDP, (ii) the price level, and (iii) the unemployment rate?

Answer 1

A recession in Asia would reduce the demand for U.S. exports to Asia and thus the aggregate demand for U.S. goods would decrease in the world market. So, in the short run, the aggregate demand would decrease and the U.S. aggregate demand curve will shift to the left. the real GDP will decrease and the price level would also decrease than before. So, in the short run, the unemployment rate would increase than before. But, in the long run the aggregate supply would increase and the quantity at full employment would come to the same level as before but the equilibrium price level would decrease in the long run.

Below is the diagram where the vertical line is the Long Run Aggregate Supply, the initial Aggregate Demand is AD and after the recession in Asia, the aggregate demand is AD₁ and the Aggregate Supply curve is AS. P^* and Q^* are the initial equilibrium points and P^' and Q^' are the equilibrium points after the decrease in the aggregate demand in the short run.