Question

Analyse how the following events will affect South Korea’s economy using the AD-AS diagram. In response to the Covid-19 pandemic, President Moon announced a supplementary budget in April 2020 to increase government spending by KRW 8 trillion to fund an emergency relief program. At the same time, firms face an increase in the cost of production due to unavailability of materials. What would happen to the output and the price level in the short run and long run in South Korea? Diagram/s are required to aid your explanation.

Answer 1

COVID-19 pandemic and subsequent measures taken to contain the spread of the virus have plunged the world economy into recession. The measures adopted to maintain social distancing measures have forced shut down of market places, businesses, and most of the firms, which has led to closure of economic activities across the country leading to millions of job losses in the world which in turn has led to steep fall in aggregate demand as well as supply.

In order to revive aggregate demand or economic growth in the country, President Moon announced an expansionary fiscal policy in the form of supplementary budget in April 2020 to increase government spending by KRW 8 trillion to fund an emergency relief program. Increase in government spending will lead to revival of aggregate demand or economic activities in the country.

However, due to the pandemic, supply chain were also heavily disrupted or broken which have increased the cost of production due to shortage in raw materials and other factors of production. Due to higher cost of production, price level will increase in the short run, which will mean that the increase in aggregate demand would result in lower than expected increase in output in the economy in the short run.

However, as supply chains are rearranged and firms come back to businesses, gradually the factors of production will reach the level before the pandemic while aggregate demand would also increase, reaching to the full equilibrium in the long run.