Question

6. How does the sudden wildfire that hit most states effect the U.S. economy in the SR? Be sure to outline the effects on U.S GDP, the price level and unemployment. What policies should the fed embark on to bailout the economy from the effects of the wildfire?

Answer 1

Solution:

In the Short Run, a sudden wildfire will lead to supply shocks (Goods and services that are dependent on the forest) in the economy. There will be less production thus employees will lose their jobs and it will lead to a higher level of unemployment. Since the production level has gone down, the prices of the related commodities and services will increase.

It will lead to a situation of stagflation (Higher inflation and higher unemployment).

hand Supply shock ASi ASo AS, AD Eo Po ADo Yx-Yo Output -> Initial Equilibrium Eo, where Price = Po and Output = Yo Due to Supply shock, ASo Shifts leftward to ASi . New Equilibrium Ei, New Price New Output = Y = P, and Scanned with LJ

Eventually, we can see that

• GDP will go down
• The price level will increase
• Unemployment will increase

Policies that the Fed should embark to bail out the situation:

The stagflation situation is very complex to handle as the Fed has to chose expansionary monetary policy to counter a lower level of growth and a contractionary monetary policy to counter the issue of inflation.

The Fed should choose contractionary monetary policy (higher interest rate) to counter the issue of inflation first and then with the help of government work towards mitigating the impact of the supply shock.