Question

The economy is starting from a point of disequilibrium – a recessionary gap. An economic shock then hits this economy and there is a sudden increase in the value of the Canadian dollar. Assume that the price level is flexible downwards as well as upwards. What is the initial impact on the price level and RGDP? Label the initial point (A) and the new point after the shift as (B). What if the price level was not flexible downwards? What would the impact be and how would you graph it? Label this new point as point (C).

If you were a Keynesian economist, how would you respond to this scenario under flexible prices? What would you advise? How will the economy adjust?

Answer 1

The economy is starting from a point of disequilibrium – a recessionary gap and an economic shock then hits this economy and there is a sudden drop in the level of household borrowing. This will lead to fall in investment. aggregate demand would further fall.



the einitial impact would be that here will be fall in price level and RGDP both.
If price level is not flexible then there will be further fall in output.