US China Trade War - An Application of the AD/AS Model

Students will be able to use the AD/AS model to analyze the effect of trade policy on the economy.

This activity is appropriate for a Principles of Macroeconomics course. It is most likely too advanced for a Survey of Economics course. It could be used in an Intermediate Macroeconomics course.
Prior to engaging in this activity, students should understand the AD/AS model. This activity is very useful to help students review the model.
There is no class size limitation.
This activity can be done in one class period. It should take about 30 minutes.

Overview

In this activity, students will analyze some of the events in the US China Trade War in 2018 using the AD/AS model and discuss the implications of tariffs.

Students are asked to read some events from 2018 when the US and China imposed tariffs against each other. Then they are asked to plot these events on an AD/AS graph to determine the potential effect on the economy. Lastly, they are asked to give their opinion of tariffs and how they affected the US economy.

Expected Student Learning Outcomes

Students will be able to use the AD/AS model to analyze the effect of trade policy on the economy.

Information Given to Students

2018 US China Trade War

We will be using the AD/AS model to analyze the effect on the US economy of the US China trade war that began in 2018 under the Trump Administration.

Use the AD/AS model to plot the rounds of the trade war.

Based on your graph and your group's analysis of your graph, which statement best describes your analysis of the US China Trade War? Please be prepared to explain your answer.

A) The tariffs helped the US economy by making foreign goods more expensive so that US businesses and consumers would buy more American made goods.

B) The tariffs ended up costing US consumers more which reduces spending and hurts the US economy.

C) The tariffs would have worked if China hadn't retaliated. Therefore, what was the point of instituting them?

D) The tariffs really had no effect. Plus, if the economy was already at the long run equilibrium, then what was the real intent of instituting them?

This activity uses the AD/AS model to analyze the effect on the US economy of the US China trade war that began in 2018 under the Trump Administration. (This is a simplified analysis of the actions taken by each country.)

The main part of the activity will be having students use their graphs to debate the effects of trade policy.

To sum up this activity, instructors should lead a discussion about tariffs and trade policy helping students to understand the pros and cons of such actions and how the intended effects may not come to fruition.

The AD/AS model allows students to see how either aggregate demand or aggregate supply is affected based on whether tariffs are placed on consumer goods, inputs, or capital goods. It also teaches students that just because one country institutes tariffs, they may not have the intended effect since the other country can retaliate with tariffs of their own.

In round one, tariffs were placed on Chinese aluminum and steel. These are mainly used by businesses, so it would tend to affect AS the most and increase the price of American-made goods, whether they are intended for domestic use or exports.

China's response in round two likely affected both AS and AD since some of the goods were consumer goods while others were inputs.

In round three, the US imposed tariffs on consumer goods imported from China, which would affect American consumers directly, and thus decrease AD.

Finally, in round four, China also imposed tariffs on consumer goods imported from America. While we don't know which tariff effect is larger, the one on Chinese consumer goods or American consumer goods, we can see that these can affect AD in different ways.

After four rounds, students should be able to see the difficulties in using tariffs and can debate whether they can achieve their intended effects.

Instructors should be prepared to help students make the connection between the various effects of the trade war and their choices. In choice A, students need to determine whether tariffs spur spending on American goods by making foreign goods more expensive. In choice B, students should be able to see the effect of the American tariffs on Chinese consumer goods and the effect of American tariffs on Chinese inputs that make American goods more expensive. (For example, when the US imposed tariffs on aluminum, it made the cost of producing cans more expensive, which affected the price of American goods sold in cans, such as beer.) Choice C raises the issue that while theoretically tariffs could help a domestic economy, one country can't control what another one does, thus the tit for tat response could turn into a trade war. Finally, choice D allows students to think about the combined effect of all the rounds of the various tariffs and question whether they had the intended effect.

Instructions for Pre-Activity

Ask students to assume the US economy is at its long run equilibrium, which is basically where it was prior to the first round of tariffs. Ask each group to start by drawing a graph of the AD/AS model showing the US economy at its long run equilibrium. (This allows all groups to begin the exercise with the economy in the same place.)

For each round, ask students to think about what has been affected in the US economy and which curve is affected and how it would shift. Using different colors or identifying the curves as Round 1, Round 2, etc., draw each round on their original graph. They will be drawing each round on top of the previous round on the same graph. (It may be a bit messy so don't worry.)

Round One - March 1, 2018. Trump imposed tariffs of 25% on steel and 10% on aluminum.

Round Two - April 2, 2018. China responded by imposing tariffs on 128 products it imports from America, including aluminum, airplanes, cars, pork, and soybeans (which have a 25% tariff), as well as fruit, nuts, and steel piping (15%).

Round Three - July 6, 2018. American tariffs on $34 billion of Chinese consumer goods came into effect. August 22, 2018, the US imposed a 25% tariff on 279 Chinese goods, worth $16 billion.

Round Four - July 6, 2018. China imposed retaliatory tariffs on US consumer goods worth $34 billion. August 22, 2018, China imposed countermeasures of 25% tariffs on $16 billion of imports from the US.

Compare the economy at the end of these four rounds to where it was before the first tariffs were imposed. That is, compare the level of GDP before and after and the price level before and after.

(Note to instructor – this question allows for a quick way to get feedback from each group as to where each group ended up.)

1. What happened to the economy in your graph? What effect did these tariffs have on price level and GDP?

This activity is assessed through the discussion of the students' answers. It could be turned into an essay or short answer question on an exam or quiz.