Question

Assume that the economy of Nicoland has a flourishing trade relationship with many nations, including the United States and an active public sector. Nicoland's economy is currently operating below the full employment level of output and trade has decreased between the two nations.

Explain the impact of the problems in Nicoland's economy on the United States economy, using aggregate demand aggregate supply analysis.

If Congress wants to repair the effects on the United States economy noted in (A) above, identify what fiscal policy action it would undertake.

Draw a correctly labeled AD/AS graph showing the impact of Congressional action on each of the following:

output

price level

Answer 1

Since Nicolands economy is operating below full employment level this will cause real GDP to below than expected levels.

As results trade relations will be lower with UsA as well due to lack of production . This implies that income is lower in Nicoland due to decreased employment and hence aggregate demand is lower and hence prices get lower causing deflationary effects. This shall create limited exports by USA to Nicoland because of lack of demand. And hence the US GDP too shall fall consequently.

To avert this situation government must adopt an expansionary monetary policy which will incur fiscal stimulus to nations and higher supply of money in market and higher disposable incomes and hence aggregate demand raises causing economy to now move towards full employment. This will then help increase GDS for both US and Nicoland. Also exports will be higher from USA and trade relations will resume back to normal.