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|Originally posted by doublec4:|
The USA is placing a tariff on softwood lumber being imported from Canada. How does this affect equilibrium income and the price level in the short run (of the Canadian economy)? How does it affect equilibrium income and price level in the long run (of the Canadian economy)? The Canadian government is going to increase program spending... will it offset the effects of the tariffs being placed on Canadian goods? What then, will happen to imflation?
Well, first of all, Equilibrium Economics is a myth. But...for the purpose of taking a test or solving a problem in a text book think of equilibrium income in terms of the law of diminishing returns. Keep in mind that most governments earned their tax revenues through tariffs until the late 19th century when income became the popular choice of taxation...popular for politicians at least. Tariffs offer many appeals in the near term because they defer income to outsiders. The effect however, as in the example above, is that supply is constrained by price increases in America. Hence, supply in Canada drops. Do you remember learning about aggregate demand? Govt purchases + Investment demand + Consumption demand = total output.
|... I'm thinking it would decrease supply which would increase the price level in the short run... not sure what that means for equilibrium income? a drop?|
Correct. the extra cost to produce goods beyond the equilibrium point grows faster than the revenues.
... in the long run I think it will decrease aggregate demand, the supply curve is fixed... so that means a price level drop I think
OK, I guess you DO remember aggregate demand
Price drop? Hmmm, yes and no. It depends on who you follow, Keynes or Modigliani, or Friedman, etc. In essence, supply is NOT fixed. I do not know what assumptions you are making so if you ASSUME supply is fixed then, yes, the price will drop.
... I have no idea what government spending will do... increase aggregate expenditures and bring up equilibrium income?
Typically govt spending increases.
Keynes underestimates the marginal propensity to consume. Savings, however, is NOT the determining factor in spending as Modigliani asserts. Credit Card debt is the life blood of modern economies.
Any model you draw will have to take into consideration a variety of valiable including demand for lumber (housing starts primarily) cost per board foot of timber (Monday's WSJ will have that number), opportunity costs (steel framing instead of timber will envigorate the US steel industry and reduce deforrestation, etc.