Question

Consider the following diagram showing the AD curves in two different economies. One economy is Autarkland—it does not trade with the rest of the world (autarky is a situation in which a country does not trade with other countries). The other economy is Openland—it exports to and imports from the rest of the world.

AD OPENLAND ADAUTARKLAND

1. Explain why an increase in the domestic price level (for a given exchange rate) reduces net exports in Openland. How would you illustrate this with the AE curve in the 45°-line diagram?
2. Explain why the AD curve is steeper in Autarkland than in Openland.
3. If there are never any net exports in Autarkland, why isn’t the AD curve vertical? Explain what other aspect of the economy generates a downward-sloping AD curve.

Answer 1

1) Domestic goods have increased in price relative to foreign goods caused foreign goods to be substitute for a domestic goods.

Hence an increase in domestic price level causes the aggregate expenditure curve shift down therefore it reduces net export in Open land

2) Trade in Openland and no trade in Autarkland. Shifting down has to be due to private sector wealth purely due to consumption

Therefore Steeper curve due to net export changes and private sector wealth much lower when both factors are in role

As per HOMEWORKLIB RULES only one question should be answered

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