Consider the economy of a country A working on its long run equilibrium prior to the...

Consider the economy of a country A working on its long run equilibrium prior to the outbreak of COVID-19. Suppose that this country has been badly affected by COVID-19 to date, over the course of past four months, after the first case has been reported.

a) By using an appropriate diagram and your knowledge of economics, show the current state of equilibrium in country A. (Refer to the concepts such as aggregate demand curve, short-run aggregate supply curve, long-run aggregate supply curve, monetary neutrality, recession, depression, stagflation, and unemployment.)

b) Is it possible for this economy return to its long-run equilibrium? Describe the possible outcomes for the next few years taking into account the two forms of policy response, that is, (i) Do nothing and wait for prices and wages to adjust, (ii) Take action by using monetary and/or fiscal policy.

Solutions

Expert Solution

Before the outbreak of corona virus (covid 19) Country A was on its equilibrium. There was full employment and no output gap was there, Potential GDP was equal to real GDP. But due to the outbreak of covid 19 , there is decrease in income, output and employment. Therefore, short run aggregate supply curve shifts backwards. Due to fall n SRAS equilibrium price will increase from p to p1 and equilibrium quantity will decrease from q to q1.

It is a situation of recession and now real GDP is less than potential GDP. It is a worst situation. To overcome the situation monetary and fiscal policy takes action

Take action by monetary and fiscal policy-

Fiscal policy used by fed is expansionary . Taxes are reduced and spending is increased. Due to that aggregate supply curve will shift rightwards and again full equilibrium will be attained. The reason is expansionary fiscal policy increase production and increase in production provides employment and employment leads to increase in income.

Expansionary monetary policy-discount rate is reduced and central bank buys government securities through open market operations. Increase money supply in banks. Interest rate falls and borrowing becomes cheaper. Investment increases. Increase in investment leads toward increase in production and increase in production provide employment and employment leads to increase in income.

Do nothing and for fluctuations in prices- It will be a difficult situation .government intervention is essential to remove the recession.

Rahul Sunny answered 2 months ago

Next > < Previous

Related Solutions

Consider an economy that initially stays at its long-run equilibrium. Policy affects the economy with a...

Consider an economy that initially stays at its long-run equilibrium. Policy affects the economy with a one-period lag. Answer the following questions: Use the 3-equations model and diagrams to provide a period by period explanation of how a negative aggregate demand shock lead to a deflation trap, where output and inflation are falling without limit. How can the government use fiscal policy to escape the deflation trap? Illustrate with diagrams. Suppose that the current public debt is already quite large,...

“COVID-19 Impacton Economy” Assume the economy of country A is in a long-run equilibrium with full...

“COVID-19 Impacton Economy” Assume the economy of country A is in a long-run equilibrium with full employment. The nominal wage of workers are fixed in the short run. a)Draw a graph which shows the short-run aggregate supply, long-run aggregate supply, and aggregate demand. Describe the equilibrium point and show each of the following: i ) Equilibrium output, labelled Y1 ii) Equilibrium price level, labelled P1. b)Owing to the outbreak of COVID19, the export market of country A has decreased. On...

Suppose the economy is in long-run equilibrium.

Scenario 1 - Pessimism Suppose the economy is in long-run equilibrium. Then because of corporate scandal, international tensions, and loss of confidence in policymakers, people become pessimistic regarding the future and retain that level of pessimism for some time. Scenario 1 - Pessimism. Which curve shifts and in which direction? aggregate demand shifts right aggregate demand shifts left aggregate supply shifts right. aggregate supply shifts left.

Consider an economy that begins in long-run equilibrium. Suppose that there is a wave of pessimism...

Consider an economy that begins in long-run equilibrium. Suppose that there is a wave of pessimism that reduces investment demand at any given real interest rate. That is, suppose that the investment demand curve shifts down and to the left. Use the IS-LM diagram and the aggregate supply - aggregate demand diagram to show how this shift down of the investment demand curve affects the interest rate, income, investment, the price level, consumption, and the supply of real money balances...

Consider the Canadian economy that is in long run equilibrium with output equal to Y*. The...

Consider the Canadian economy that is in long run equilibrium with output equal to Y*. The United States economy goes into a major slowdown causing a significant decrease in goods and services shipped into the United States from Canada. For the Canada, answer the following questions: A) What kind of shock occurred- aggregate demand or aggregate supply? Explain your answer. B) Explain the how fiscal policies by government of Canada can be used to drive the economy back towards Y*...

A country is initially at the long-run and short-run equilibrium. However, in the short-run, the country...

A country is initially at the long-run and short-run equilibrium. However, in the short-run, the country experiences a drop in the general price level and the real GDP at the same time due to a temporary shock and we know there is one shock only. (a) Which curve(s) in the LRAS-SRAS-AD diagram must have shifted to generate the observation above? If any of the curves has shifted, state the direction of the shift, propose a factor that leads to the...

Let the economy of a country named, Happy Land be in a long-run equilibrium position. Using...

Let the economy of a country named, Happy Land be in a long-run equilibrium position. Using a diagram, explain how each of the following affects equilibrium real GDP and price level in the short-run, as well as in the long-run: A) An increase in income tax rate B) An decrease in exchange rate C) A significant increase in foreign income caused by an economic boom in the rest of the world D) A decrease in nominal money supply

Consider an economy that is initially in long-run equilibrium. Unexpectedly, there is a sudden massive decrease...

Consider an economy that is initially in long-run equilibrium. Unexpectedly, there is a sudden massive decrease in house prices. a) Explain why this is likely to lead to a reduction in private consumption. Theoretically, could consumption also increase? Explain. (3 points) b) Show in the AS-AD diagram, and explain, the consequences of this decline in consumer spending. (3 points) c) If the central bank does not change its monetary policy rule, how will it react to the situation in (b)?...

Consider the AS-AD model where the economy is not in long-run equilibrium, in particular, assume there...

Consider the AS-AD model where the economy is not in long-run equilibrium, in particular, assume there is a negative output gap (that is, the economy is in a recession). (a) Describe the adjustment under fixed exchange rates if there is no government intervention. (b) Contrast your answer with that under flexible exchange rates

Consider the Canadian economy that is in long run equilibrium with output equal to Y*. Canada...

Consider the Canadian economy that is in long run equilibrium with output equal to Y*. Canada and the United States have established a new free trade agreement that results in a significant increase in goods and services imported into the United States from Canada. For the Canadian economy, answer the following questions. use separate diagrams for each question. 1 illustrates the initial equilibrium in a diagram using AD and AS model. explain the diagram 2. what kind of shock occurred...

Subjects