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. a. an increase in government purchases b. a reduction in nominal wages c. a major improvement in technology d. 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).

In Goa the multiplier effect of “iron ore exports” is “1.62”. Now, the additional “1,000 rupees of iron ore exports” increase the domestic GDP by “1.62*1,000 = 1,620 rupees”.

2).

a).

Let’s assume that the initial equilibrium is “E1” the intersection of “AD1” and “AS1”, => the equilibrium price and the output are “P1” and “Y1” respectively.

AS1 Excess Demand AD2 AD1 Y1Y2

Now, as the “G” increases that increase the AD, => the AD shift right side to AD2, => at the initial price “P1” there is an excess demand that increase the price. So, as “P” starts rising the “AS” increases and “AD” decreases until an equilibrium established. So, the new equilibrium is “E2” the intersection of “AD2” and “AS1”. So, as the “government spending” increase the “P” and “Y” both increases.

b).

Let’s assume that the initial equilibrium is “E1” the intersection of “AD1” and “AS1”, => the equilibrium price and the output are “P1” and “Y1” respectively.

AS1 AS2 1E3 Excess Supply E2 AD1 Y Y2Y3

Now, a reduction in “nominal wage” decreases the cost of hiring more worker, => cost of production decreases implied the AS increase, => the AS shift right side to AS2, => at the initial price “P1” there is an excess supply that decrease the price. So, as “P” starts falling the “AS” decreases and “AD” increases until an equilibrium established. So, the new equilibrium is “E2” the intersection of “AD1” and “AS2”. So, as the “nominal wage” decrease the “P” decreases and “Y” increases.

c).

Let’s assume that the initial equilibrium is “E1” the intersection of “AD1” and “AS1”, => the equilibrium price and the output are “P1” and “Y1” respectively.

AS1 AS2 1E3 Excess Supply E2 AD1 Y Y2Y3

Now, a major improvement in the technology increase the output production at the same input requirement implied it decreases the cost of production implied the AS increase, => the AS shift right side to AS2, => at the initial price “P1” there is an excess supply that decrease the price. So, as “P” starts falling the “AS” decreases and “AD” increases until an equilibrium established. So, the new equilibrium is “E2” the intersection of “AD1” and “AS2”. So, as the “nominal wage” decrease the “P” decreases and “Y” increases.

d).

Let’s assume that the initial equilibrium is “E1” the intersection of “AD1” and “AS1”, => the equilibrium price and the output are “P1” and “Y1” respectively.

SRAS1 Excess Supply AD1 AD2 Y3 Y2Y1

Now, a reduction in “NX” decreases that increase the AD, => the AD shift left side to AD2, => at the initial price “P1” there is an excess supply that decrease the price. So, as “P” starts falling the “AS” decreases and “AD” increases until an equilibrium established. So, the new equilibrium is “E2” the intersection of “AD2” and “AS1”. So, as the Net Export decrease the “P” and “Y” both decreases.