Question

1. In Goa, India, the multiplier effect of iron ore exports is calculated to be 1.62 (Ta, 2003). Calculate the impact of an additional 1,000 rupees of iron ore exports on the economy of Goa.

2. Use the model of aggregate demand and short-run aggregate supply to explain how each of the following would affect real GDP and the price level in the short run.

1. an increase in government purchases
2. a reduction in nominal wages
3. a major improvement in technology
4. a reduction in net exports

3. The United Kingdom (UK) held a national referendum (vote) on whether the UK should remain in the European Union (EU), or should exit the EU. Exiting the EU is likely to have several consequences: (1) increased barriers to trade between the UK and the remaining EU countries; (2) Reduced refugee flows.

Use the AS/AD model to describe the short run and long run effect of the UK exit from the EU.

Answer 1

(1) When exports increase by 1,000 rupees, Income (GDP) increases by (1,000 x 1.62) = 1,620 rupees.

(2) In following graphs, initial equilibrium is at point A where AD0 (aggregate demand) and SRAS0 (short-run aggregate supply, which slopes upward in intermediate range) curves intersect, with initial equilibrium price level P0 and real GDP Y0.

(a) Increase in government spending purchases raises aggregate demand, shifting AD curve rightward and increasing both price level and real GDP. In following graph, AD curve will shift rightward from AD0 to AD1, intersecting SRAS0 at point B with higher price level P1 and higher real GDP Y1.

(b) Reduction in nominal wage decreases production cost, thus increasing aggregate supply. SRAS curve shifts rightward, decreasing price level and increasing real GDP. In following graph, SRAS curve will shift rightward from SRAS0 to SRAS1, intersecting AD0 at point B with lower price level P1 and higher real GDP Y1.

(c) Improvement in technology effectively decreases production cost, thus increasing aggregate supply. SRAS curve shifts rightward, decreasing price level and increasing real GDP. In following graph, SRAS curve will shift rightward from SRAS0 to SRAS1, intersecting AD0 at point B with lower price level P1 and higher real GDP Y1.

(d) Reduction in net exports lowers aggregate demand, shifting AD curve leftward and lowering both price level and real GDP. In following graph, AD curve will shift leftward from AD0 to AD1, intersecting SRAS0 at point B with lower price level P1 and lower real GDP Y1.

NOTE: As HOMEWORKLIB Answering Policy, 1st 2 questions have been answered.