Question

Question 2: [50 marks] The COVID-19 pandemic is causing tremendous hardship around the world. A recession, likely a severe one, is inevitable. A. Show the short run effects of a decrease in the demand for goods and services caused by the pandemic. Suppose the economy is an open economy that is on a flexible exchange rate. To answer this question, draw the following five diagrams: 1. The goods market, [3 marks] 2. The money market, [3 marks] 3. The IS-LM curves, [3 marks] 4. The interest parity condition, and [3 marks] 5. The AS-AD curves. [3 marks]

Answer 1

A. 1. Goods market equilibrium is when savings are equal to investment. A decrease in the demand for goods and services would be increasing the savings because there will be no expense and the disposable income with the consumer will be left unused which therefore will be used in the savings. On the other hand, as the consumer will be demanding less of the goods and services, the producers will be investing less in their good's production.

savings, S Real Interest Rate Investment, S=1 Desired National Savings and Interest

2. Money market equilibrium is when the rate of demanded interest is equal to the supply of money. Or we can say that the money demanded by the citizens is equal to the money supplied by the regulatory authorities. When the demand for goods and services goes down, then the money demand and supply both go down because there is less transaction of money in the economy.

Ms' Real Interest Rate Money supply, Ms Md' Money demand, Md Quantity of Money

3. In the IS-LM curve, the money market will be seeing a downfall because of less flow of money in the economy, therefore, the LM curve will be shifting leftwards. Whereas, the government spending also get lesser because of lesser production in the economy, therefore, the IS curve also shifts leftwards.

Real Interest A Rate LM >> Output

4. It is used to explain the changes in the exchange rates. The demand and supply of the interest rate will be lowered when there will be no demand for goods and services.

Real Interest Rate > Exchange Rate

5. The aggregate demand and aggregate supply are the totals of all the demands and all the supplies by the population. As the demand for goods and services falls, the AD will fall too, whereas the supply of goods will also decrease because production will not be there unless there is demand from the consumer size.

Price Quantity demanded and supplied

B. 1. In the medium run, the AS and AD curve will be coming back to their initial equilibrium ( refer to the previous graph). This is because as the people will have to survive while staying at home during the time of COVID-19 and they have to buy food from the market for which they would be demanding and the producers would be producing at the initial level itself at which the economy was producing.

2. In the IS and LM graph, the IS is the production criteria (goods market) whereas the LM is monetary criteria (money market). In the medium run, the goods and money market both will come to equilibrium (refer to the respective graph) because the goods will at the end be demanded by the citizens to survive and hence the saving and investment patterns will go to the usual cycle and the money will again start flowing in the same way in the economy.

C. the fiscal policy that returns the output back to its natural level is by opening the domestic borders for the transport to arrive in other districts so that people have options to buy products and demand them. When there will be more flow of income, the taxes can also be incurred from the people in natural manner.