Question

1. Use the Aggregate Demand and Aggregate Supply model to explain the current crisis in both graphs and words. Explain only the current economic contraction without talking about the government and Federal Reserve responses. Start with thinking about how AD and/or AS would be affected by the social distancing measures which mean that people would stay home, unemployment rises, and non-essential businesses close. (200-250 words)

Answer 1

The pandemic has consumed many lives but there are economic repercussions which need to be analysed as well. Many economists have claimed that recession has set in and that the world economy will be going through a contradictonary phase. The shutdown has had an impact on various industries such as hotels, tourism, entertainment, which will be leading to an increase in the unemployment rates. The impact of this crisis can be seen on both the aggregate demand and aggregate supply.

The aggregate demand has seen to rise only for essentials such as toilet paper as people were hoarding these goods. In general, however the aggregate demand has reduced because of various reasons:

(i) The social distancing and shutdown of economies have caused a reduction in the consumption of many goods and services like restaurants, malls.

(ii) The reduced business activities and the temporary shut down of production activities has increased the unemployment levels which will have an impact on the purchasing power. The reduction in the purchasing power will also lead to a reduction in the aggregate demand.

(iii) The daily wage earners who have lost jobs due to the shutdown have also no means to purchase various goods and services which has reduced the aggregate demand.

(iv) There has been a halt on trading between economies which would also impacted the aggregate demand and supply as the traders would have lost income to demand for goods and services.

The crisis has also had an impact on the aggregate supply due to a number of reasons:

(i) The shutdown of the economies also meant that the production of various goods and services which are not essential were halted which has reduced the aggregate supply of goods and services in the economy.

(ii) The supply chains have seen to be affected as a whole which will reduce the aggregate supply in the economy.

This can be seen in the graph that both the aggregate demand and aggregate supply has reduced which has led to an increase in the price level to P1 and reduction in the real GDP to Y1.

-SRAS, SRAS Price Level TAD 'AD Real GDP