Question

if the U.S currency becomes stronger (the value of a dollar increases), there is a change in International valrables. How does this situation affect the Ad-AS diagram? what will happen to the equilibrium price level and real GDP in the short run? is the economy experiencing an inflationarygap or recessionary gap?

Answer 1

In case the dollar appreciates then this will mean that US goods will become more expensive to those abroad and foreign goods will appear cheaper and so imports increase. This will worsen the balance of trade situation. The AD curve will then shift leftwards and so cause a fall in the equilibrium price level and also the level of real GDP. As the currency appreciates the capital flows into the country will also fall and the outflows will increase.Assuming the economy is initially in equilibrium then this will mean that the economy falls below equilibrium and the economy faces a recessionary gap. The economy is thus below full employment and hence it faces a recessionary gap.