Question

Starting with the long-run equilibrium in the aggregate demand and supply (AD-AS) model. Consider the macroeconomic effects of the lockdown measures due to COVID-19. In each part of your answer, please be brief and concise in less than 100 words. You need to make assumption clear, reasonable and explicit if making any. The quality and logic of arguments determine your marks.

a)Explain this development in the AD-AS framework in words (Diagrammatic representation not required)

c)Fiscal and monetary policy measures can be taken as the response to the development in part a). Explain the policy measures in writing. Diagrammatic representation of the effects of these policies not required. d)What are the possible long run impacts of the recommended policy measures in part (c). Explain the impact in writing. Diagrammatic representation not required.

E)Continue on the long-run, the government starts to register the budget surplus after having paid off the large budget deficits incurred as the policy measured in part c). What happens to the quantities of saving and investment and (real) interest rates with this development? Explain in writing. Diagrammatic representation not required (Hint: try to explain the step by step).

Answer 1

( a ) Because of lockdown measures most of the businesses have been shut. Only some service sector work such as those in software industry could be carried on with employees working from home. Shutting down of majority of businesses has led to layoffs of millions of workers. Sudden loss of jobs has led to massive fall in income for all the affected workers which has reduced aggregate demand in the economy. Sudden closure of businesses has also disrupted supply chains impacting aggregate supply negatively. Thus, both aggregate demand as well as aggregate supply curve will shift to the left.

( b ) Fiscal and monetary measures can be used to push aggregate demand up. With gradual opening of businesses supply chain is also expected to get back on track. Fiscal measures such as reduced taxes for businesses as well as for individuals, increased government spending will help aggregate demand go up and aggregate demand curve shift to the right. Monetary measures in the form of reduced interest rates will infuse liquidity into the economy helping in revival of aggregate demand.

( E ) With government facing budget surplus, more money would be available in the market which will bring down the interest rate. Saving rate as well as investment will increase.