The strong recovery in US domestic demand has spilled over to the rest of the global economy. The largest economy in the world is sucking in goods from the rest of the world at a record rate, either to restock inventories or for final consumption. The US trade deficit in goods was over $93 billion in June; its overall trade deficit was lower because the US has a surplus in services trade. India has been one of the beneficiaries of rising demand from countries such as the US. Indian goods exports have had a splendid run in recent months.

Source: Livemint (2021)

1. Use the AD-AS model to examine the short-run effect of this event on the Indian economy. What is the short-run effect on GDP, price level and unemployment? Assume that initially the Indian economy is in a long-run equilibrium.

2. Explain how the economy may correct itself in the long run even without any intervention by the policymakers.