Question

Assume that Australia’s macroeconomic equilibrium starts at full employment. There is a slower economic growth in a number of Australia’s trading partners including China and Indonesia.  As a result, the demand for Australian beef from these countries decreases. Using AD- AS model, explain carefully the immediate and long-term effects of this event towards the Australian economy. Draw the appropriate Aggregate Demand-Aggregate Supply diagram to support your explanation.

Answer 1

The full-employment equilibrium is A, since AD, SRAS, and LRAS intersect, where Yp output is produced at P price.

LRAS shows the potential (full employment) stage; the economy moves from A to A’ because of decreasing export to China and Indonesia as their demand decreases; this thing shifts the AD curve to the left as AD1, creates equilibrium at A’ where (AD1 = SRAS). In the short-run the economy will stay at A’, where both Y and Price decreases as Y1 and P1 respectively. This is also known as recessionary gap.

In the long-run, such decrease in demand may not sustain; the economy will slowly move toward full employment by shifting AD1 to AD and by reaching the equilibrium A. Once it is achieved, Y would be increased to Yp and Price would be increased to P.