Question

A wide part of Australia has experienced severe fires in the last year, which made the economy much less productive and had severe impacts on business activities.

a) Explain why you could expect negative shifts in the aggregate demand curve following the fires. What would you expect are the drivers of this shift? Reflect on each of the components of the aggregate demand and comment on whether they are likely to change due to the fires.

b) Explain why you could expect negative shifts in the aggregate supply curve following the fires. What would you expect are the drivers of this shift? Reflect on each of the components of the aggregate supply and comment on whether they are likely to change due to the fires.

c) Show the shifts discussed in parts a) and b) graphically. You may assume an upward sloping AS curve for simplicity. Can you predict what happens to real GDP and the price level?

d) The fires in Australia can also be considered a decrease in the country’s stock of capital. You may use the Solow model to show what happens when capital decreases and what the model predicts for the new growth rate. Are these consequences likely to happen in practice?

Answer 1

a) Due to the Australian wildfire, the economy got a decrease in aggregate demand due to some of these reasons.

1. it hit the tourism sectors.

2. it impacted negatively the forest and wooden furniture-related business.

3. to control the fire and settlement of wildlife and forest, there is a huge government spending

4. indirect impact on the production process as the pollution level is high

overall it impacted 0.4% of the economy. and it impacted the consumer demand shift left.

b) The wildfire not only impacted the aggregate demand also impacted the supply. there are some of the points which may be the reason for the decrease in supply.

1. it impacted the cattle business around 2%.

2. low rainfall, and it impacted directly to the supply of agricultural products.

3. Damage of vegetable firming due to heat in the environment.

4. 14% of total firming land got burned.

so these are some of the reasons which have a direct and indirect impact on aggregate supply to shift left.

c)when there is a shift in both AD and AS to leftward the output level also affected by it and it decreases in quantity from Q1 to Q2 where the price is shifted from P1 to P2. This short term shift in price and quantity purely due to the emergency and it will take some time to get back to the original position.

d) The wildfire is having an impact on capital stock as the government has spend a huge amount of money to control and settlement for normality. it also impacted in terms of low supply and low demand so overall there is a decrease in capital stock from the potential level K* to K1 where the output per worker or investment per worker shifted from Y* to Y1.

The X-axis represents as capital stock.