Question

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

AD includes consumption , investment, government consumption expenditure and net profits.when UK exit the EU then there will be trade barriers for UK that means there net exports will decrease.also there is a chance that firms are using some imported goods as input ,now that good has been restricted.now firms have to get that input at higher prices ,it will increase their cost and thus decrease their profit.due to fall in their profit firms will decrease their investment.on other hand reduced refugees flows also lower the aggregate demand because they are also the demand source of domestic goods.so by all effect aggregate demand will decrease and AD curve shift downward and output and price level will fall in short run.

A decrease in AD leads to an decrease in real GDP and the price level.

In the long run, a decrease in the price level will drive down input prices and expectations about inflation, which leads to the increase in aggregate supply and curve will shift rightward.output will increase and price will fall. Output keeps rising and price level keeps lowering until real GDP returns to full employment output. As long as output is lower than natural employment output, an unemployment rate that is higher than the natural rate will put downward pressure on wages and prices. The long-run outcome is that real GDP returns to the full employment level of output and the unemployment rate is equal to the natural rate. The price level, however, is now permanently lower than before.