Question

Ecoland is initially producing its potential output. It is a major producer of copper, all of which it sells to firms abroad. An increase in international demand for copper increases demand for copper exports.

Describe the effect of this increase in demand for exports on Ecoland's real GDP and price level in the short run.
Describe the adjustment process that will bring Ecoland's real GDP back to its potential?

Answer 1

An increase in demand for Ecoland's copper exports leads to short-term increases in real GDP and price level due to a rightward shift in the aggregate demand curve. Adjustment in the long-term occurs as the economy experiences inflationary pressures, bringing real GDP back to its potential output level, thus restoring equilibrium.

Step-by-step explanation:

Ecoland, a major producer of copper that sells all of its production abroad, experiences an increase in international demand for its copper exports. This surge in demand shifts Ecoland's aggregate demand curve to the right, which in the short run, leads to an increase in real GDP and the price level. As copper exports rise, the economic output exceeds its potential; however, this is not sustainable in the long term.

Over time, the adjustment process involves an inflationary response, where the increased price level will reduce the real value of money, dampen domestic consumption, and eventually lead to a reduction in aggregate demand. This process brings Ecoland's real GDP back down to its potential output level. Equilibrium is restored as the export-driven increase in aggregate demand primarily translates into higher prices rather than a long-term increase in output.