Question

In response to the announced British departure from the EU, consumption fell in Britain and the uncertainty concerning Brexit has caused firms to postpone Investment. 1) Using an AS-AD diagram, analyse the short-run implications of these developments for real GDP. [15 marks] 11) Many economists have argued that Brexit will permanently lower potential output in the UK. Assuming this is the case, indicate on the AS-AD diagram the long-run equilibrium of the economy, [20 marks] iil) Mark Carney, the Governor of the Bank of England has vowed to Increase the money supply in Britain in response to Brexit. Explain briefly in words the implications of this in both the short run and the long run. [10 marks]

Answer 1

Consumption fell in Britain and investment has postponed.

i) Aggregate demand = Consumption + Investment + Government Spending + Exports - Imports

As consumption as well as investment level fell down, there will be a decline in aggregate demand in the economy. As aggregate demand curve shifts to its left from AD to AD1, price fall from P to P1 and real GDP fall from Y to Y1.

ii) If Brexit will permanently lower potential output in the economy, it will create a recessionary gap in the economy where gap shows pre-Brexit and post Brexit output level.

اله AS CX--+ Recesscondy I Gap >

iii) If Government of England raises the money supply in the economy, it will rarely effect the aggregate demand, interest rate and output level in short run because it s very short time to reach extra money in economy.

In long run, as people have more money in their hands to spend on goods, people will change their spending pattern and tends to spend more money as their willingness to pay for goods rises with more money in hand. It will raise the aggregate demand in England.