Question

Because of corona pandemic, many economies have experienced a decrease in the amount of labor it employs. Use the AD / SRAS model to explain what happens to real GDP? What happens to labor productivity?

Answer 1

The corona virus has been declared as a pandemic by the WHO and has increased its footfall across major countries of the globe, which in response to the virus have resorted to Lock down measures in which availability of all goods and services has been restricted and only essential goods such as food grains and groceries are allowed.

It is believed that as a result of this, the demand for goods and services will fall. This is evident as these goods cannot be bought. Sectors such as aviation, travel and tourism, real estate and automobiles is worst hit as it requires significant investment or the hazard is too big for people to take.

With these measures in place, it is rightly estimated that the Aggregate Demand will indeed fall. The end result would be that suppliers would also be hit, due to lack of demand itself or due to lack of the ability to produce under a lock down situation,

Companies then, would be left with no other option but to fire selected employees to save themselves from accumulating significant loss to business.

As companies begin firing people and the total production decline, the total value of the final goods or services in the country or the GDP as it is called (Gross Domestic Product) would also decline in value.

Labour productivity on the other hand would significantly decrease as the demand is connected to the need for building supplies. In a phase when there is no significant need for labour, the drop in productivity is pretty evident.

The response to this, from the governments is expected to be expansionary fiscal and monetary policies and bail outs for the industries to allow them to return to normal levels.

Please feel free to ask your doubts in the comments section.