Question

Suppose in an economy exports are increased. Describe in detail the impact of this on on...

Suppose in an economy exports are increased. Describe in detail the impact of this on on the equilibrium output and inflation in the AD-AS model, including with graphs. Make sure to make a difference between the short-run and the long-run equilibrium. Would this affect the potential output? How/why/why not?

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Answer #1

Exports are a part of net exports component of AD. Higher exports means higher Net exports and increased AD. Economy starts off at E. Increased AD shifts the AD curve rightwards. In the short run, this event raises the price level and the real GDP in the short run at F.

There is an inflationary gap in the short run now and real GDP is beyond its potential level. Higher expected price level will reduce production in the long run. This is because nominal wages are revised upwards and this shifts the AS curve left. Price level rises further up while real GDP returns to its potential level. The new equilibrium at G has higher price and unchanged real GDP

Potential output is unaffected since resource amount and status of technology both remain unchanged.

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