A decline in foreign demand for the US goods: Suppose the European and Japanese economies succumb to a recession and reduce their demand for the US goods for several years. Using the AS/AD framework, explain the macroeconomic consequences of this shock, both immediately and over time.

It is important to note that the demand curve is shifted by both foreign and domestic demand. There will be a shift in the demand curve in the short run and a shift in the supply curve in the long run.

Explanation:

The market starts at equilibrium where the long run aggregate supply (LRAS), the short run aggregate supply (AS) and the aggregate demand are in equilibrium at point A.

The recession in both Japan and Europe causes the two countries to decrease their demand for American goods and therefore the AD curve shifts to the left (AD’) and in the short run there is a decrease in both the price and the output/income represented by point B. Consequence: The Us has to sell at a lower price at a lower output . Now in the long run the America market ( the producers, firms and workers) will adjust their expectations leading to a right shift of the AS curve to AS’ and the long run equilibrium is at point C,  (consequence)where the output/income is the same at a lower price. Note that the LRAS is fixed because of the fixed supply of the factors of production.  

answer: b. false

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