Question

Incorporating COVID-19 pandemic into the AS/AD model

Q. How can we think of the COVID-19 shock(s) in the AS/AD framework?

Explain the intuition and show your arguments in a diagram

Answer 1

The Corona Virus Pandemic has created grievous problems for countries across the globe. Companies have been shut and strict lock downs have been implemented across all major countries where the pandemic has extended. The health implications of the disease are such that it would reduce the working population and decrease the productivity on hand, and on the other it has major implications for the aggregate demand and supply as companies remain shut and unemployment and low demand issue happens.

In context of the case study, the effects of the Covid 19 Shock to the AS-AD curve is as follows: -

AS-AD Framework: -

Due to the rise in Corona Virus cases, countries have shut their borders and have asked people to stay back at home and all shops except for those that supply essential commodities are told to stay shut. The Aggregate Demand will certainly take a deep hit as people are left with no choice but to consume those goods and services which are essential in nature.

Due to this, the general price level in the economy would be such that the prices of goods and services will fall. Further, Aggregate Supply would also reduce as people no longer demand goods and services and accordingly many establishments will fail. Also, since these establishments are not operating, it is also a reason for concern and the overall GDP or gross domestic product which is the final value of goods and services in any economy would decline and come to a standstill.

The same can be explained in the form of the following graph: -

Here, we can clearly see, that the price levels in the economy fall, and the Overall GDP falls from Y1 to Y2. The Aggregate demand shift is indicated from AD1 to AD2 and the subsequent Supply shift can be calculated from the slope of the curve between AD1 and AD2 respectively.

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