Question

Assume that Canada is initially in long run equilibrium with price level of P1 and GDP of Y1. Discuss how each of the following four events would affect aggregate demand, the price level and real GDP of Canada (no graphs needed).

India reduces tariffs on goods imported from Canada

Answer 1

If India reduces tariff on Canada’s import then it will boost the Canada’s export and it will increase the aggregate demand of Canada. Canada’s AD shift rightward leading to an increase in price and output.

Thus equilibrium price in Canada and GDP both will rise if GDP is below potential GDP.

However in long run equilibrium, supply curve is perfectly inelastic and any increase in aggregate demand only leads to an increase in price level only.

Thus equilibrium price will definitely increase and quantity may increase or remain same