Chapter 27: Problem 16
Use the following information to work Problems \(14-16\) According to the East Asia and Pacific Economic Update published by the World Bank in April 2015 the following factors have affected China's real GDP in 2015 Global economic recovery supports a moderate increase in China's exports. China benefits from a fall in the world price of oil Chinese government to cut excess capacity in heavy industry. U.S. firms to relocate their labor-intensive manufacturing industries to low-cost countries. Explain the combined effects of these factors on China's real GDP and the price level, starting from a position of long-run equilibrium.
Short Answer
Expert verified
Effects on China's real GDP and price level depend on the relative magnitude of shifts in AD and SRAS. There could be increases or decreases in both real GDP and price level.
Step by step solution
01
- Understand the Initial Conditions
Begin by considering China’s economy starting in long-run equilibrium. This means that the economy is producing at its potential output, with aggregate demand (AD) equalling long-run aggregate supply (LRAS).
02
- Analyze the Effect of Global Economic Recovery on China's Exports
A global economic recovery increases the demand for China's exports. This shifts the aggregate demand curve (AD) to the right due to increased foreign consumption of Chinese goods.
03
- Consider the Impact of Falling World Oil Prices
The fall in world oil prices reduces production costs for many industries. This could make it cheaper for companies to produce goods and services, shifting the short-run aggregate supply curve (SRAS) to the right as production becomes more cost-effective.
04
- Examine the Chinese Government Cutting Excess Capacity in Heavy Industry
When the government cuts excess capacity in heavy industries, it reduces the supply of these goods. This can shift the SRAS to the left because reducing production capacity generally makes supply more limited.
05
- Analyze the Effect of U.S. Firms Relocating Manufacturing
If U.S. firms relocate their labor-intensive manufacturing to lower-cost countries, it can increase competition for China's manufacturing sector. This might reduce aggregate demand for goods produced by China, shifting the AD curve leftward.
06
- Combine the Effects
Combining all effects:
07
Step 6.1 - Effect on Aggregate Demand (AD)
Global economic recovery increases AD (shift right), while U.S. firms relocating decreases AD (shift left). The overall net effect on AD depends on the relative magnitude of these changes.
08
Step 6.2 - Effect on Aggregate Supply (SRAS)
Fall in oil prices shifts SRAS right (lower costs), while cutting excess capacity shifts SRAS left (limited supply). The overall net effect on SRAS will also depend on the magnitude of each shift.
09
- Final Impact on Real GDP and Price Level
If the net effect of these shifts results in a rightward shift of AD or SRAS or both, it would increase real GDP and could either increase (AD shift dominates) or decrease (SRAS shift dominates) the price level. Conversely, if AD shifts left more than SRAS shifts right, real GDP might decrease with price level change depending on the magnitude.
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Key Concepts
These are the key concepts you need to understand to accurately answer the question.
aggregate demand
Aggregate demand (AD) refers to the total amount of goods and services demanded across all levels of an economy at a given overall price level and in a given time period. It is represented on a graph where the x-axis is the real GDP and the y-axis is the price level. Several factors can affect aggregate demand, including consumer spending, investment spending by businesses, government spending, and net exports (exports minus imports).
In the context of China's economic activity in 2015, an increase in global economic recovery helped drive up China’s exports. This economic recovery means that other countries were buying more Chinese goods, thus increasing China's aggregate demand. Therefore, the AD curve shifts to the right, indicating higher overall demand in the economy.
However, this increase could be countered by factors such as U.S. firms relocating manufacturing to lower-cost countries. This would reduce the demand for Chinese-made goods, thus shifting the AD curve to the left.
In the context of China's economic activity in 2015, an increase in global economic recovery helped drive up China’s exports. This economic recovery means that other countries were buying more Chinese goods, thus increasing China's aggregate demand. Therefore, the AD curve shifts to the right, indicating higher overall demand in the economy.
However, this increase could be countered by factors such as U.S. firms relocating manufacturing to lower-cost countries. This would reduce the demand for Chinese-made goods, thus shifting the AD curve to the left.
aggregate supply
Aggregate supply (AS) refers to the total quantity of goods and services that producers in an economy are willing and able to supply at a given overall price level and in a given time period. It is divided into short-run aggregate supply (SRAS) and long-run aggregate supply (LRAS).
Short-run aggregate supply can change due to factors like production costs and changes in the labor market or technology. In China's case, lower world oil prices in 2015 reduced the production costs for many industries. This made it cheaper to produce goods and services, resulting in a rightward shift of the SRAS curve.
On the other hand, the Chinese government’s decision to cut excess capacity in heavy industries limited the supply of these goods. This shifted SRAS to the left because reducing production capacity generally makes supply more limited. The overall impact on SRAS would depend on the magnitude of these opposing forces.
Short-run aggregate supply can change due to factors like production costs and changes in the labor market or technology. In China's case, lower world oil prices in 2015 reduced the production costs for many industries. This made it cheaper to produce goods and services, resulting in a rightward shift of the SRAS curve.
On the other hand, the Chinese government’s decision to cut excess capacity in heavy industries limited the supply of these goods. This shifted SRAS to the left because reducing production capacity generally makes supply more limited. The overall impact on SRAS would depend on the magnitude of these opposing forces.
economic equilibrium
Economic equilibrium occurs when the quantity of goods and services demanded equals the quantity supplied at the current price level. It is represented by the intersection of the aggregate demand (AD) and aggregate supply (LRAS or SRAS) curves.
In 2015, China's economy began in a state of long-run equilibrium, which means AD equaled LRAS. The aforementioned factors shifted both the AD and SRAS curves. The overall effect on equilibrium would depend on the relative magnitudes of these shifts. If both AD and SRAS shift rightward, it could lead to higher real GDP and potentially vary the price level (increase or decrease depending on which shift dominates). Conversely, if AD shifts left more than SRAS shifts right, real GDP might decrease, again depending on the magnitude of each shift.
In 2015, China's economy began in a state of long-run equilibrium, which means AD equaled LRAS. The aforementioned factors shifted both the AD and SRAS curves. The overall effect on equilibrium would depend on the relative magnitudes of these shifts. If both AD and SRAS shift rightward, it could lead to higher real GDP and potentially vary the price level (increase or decrease depending on which shift dominates). Conversely, if AD shifts left more than SRAS shifts right, real GDP might decrease, again depending on the magnitude of each shift.
global economic recovery
A global economic recovery refers to an improvement in the economic performance of economies around the world. This recovery can affect individual countries in different ways.
For China, the global economic recovery in 2015 meant an increase in exports due to higher demand for Chinese goods and services from other countries. As a result, aggregate demand increased, shifting the AD curve to the right.
This boost in aggregate demand could lead to higher national income and employment levels. However, the final outcome depends on other concurrent factors like production costs and policies that could affect aggregate supply.
For China, the global economic recovery in 2015 meant an increase in exports due to higher demand for Chinese goods and services from other countries. As a result, aggregate demand increased, shifting the AD curve to the right.
This boost in aggregate demand could lead to higher national income and employment levels. However, the final outcome depends on other concurrent factors like production costs and policies that could affect aggregate supply.
oil prices impact
Oil prices play a critical role in an economy as they affect production costs and consumer prices. Lower oil prices reduce the cost of transportation and production for many goods and services, leading to lower overall production costs for businesses.
In 2015, falling world oil prices benefitted China's industries by reducing their production costs. This resulted in a rightward shift of the short-run aggregate supply (SRAS) curve. The lower costs made it cheaper for businesses to produce and sell their goods, potentially increasing the supply of goods and services in the economy.
This rightward shift of the SRAS would likely lead to higher real GDP as production becomes more efficient. It could also impact the price level, generally leading to lower prices if the supply increase is significant.
In 2015, falling world oil prices benefitted China's industries by reducing their production costs. This resulted in a rightward shift of the short-run aggregate supply (SRAS) curve. The lower costs made it cheaper for businesses to produce and sell their goods, potentially increasing the supply of goods and services in the economy.
This rightward shift of the SRAS would likely lead to higher real GDP as production becomes more efficient. It could also impact the price level, generally leading to lower prices if the supply increase is significant.
government policy effects
Government policies can have significant direct and indirect effects on an economy’s aggregate demand and aggregate supply.
In China’s case, the government’s decision to cut excess capacity in heavy industries aimed at reducing inefficiencies but also limited the supply of those goods. This led to a leftward shift in the short-run aggregate supply (SRAS) curve.
While limiting supply, such policies can aim for long-term sustainability and efficiency. However, in the short term, it can lead to a decrease in the supply of certain goods, affecting overall economic equilibrium.
When combined with other factors like global economic recovery and falling oil prices, the net effect on China’s economy in 2015 had mixed outcomes that ultimately depended on the strengths of these individual shifts on AD and SRAS.
In China’s case, the government’s decision to cut excess capacity in heavy industries aimed at reducing inefficiencies but also limited the supply of those goods. This led to a leftward shift in the short-run aggregate supply (SRAS) curve.
While limiting supply, such policies can aim for long-term sustainability and efficiency. However, in the short term, it can lead to a decrease in the supply of certain goods, affecting overall economic equilibrium.
When combined with other factors like global economic recovery and falling oil prices, the net effect on China’s economy in 2015 had mixed outcomes that ultimately depended on the strengths of these individual shifts on AD and SRAS.
