Question

“ COVID-19 (Coronavirus disease 2019) Impact on Economy ”   

Assume the economy of country A is in a long -run equilibrium with full employment. The nominal wage of workers are fixed in the short run.

a)Draw a graph which shows the short-run aggregate supply, long-run aggregate supply, and aggregate demand. Describe the equilibrium point and show each of the following:

i)Equilibrium output, labelled Y1

ii)Equilibrium price level, labelled P1.

b)Owing to the outbreak of COVID19 (Coronavirus disease 2019), the export market of country A has decreased. On your graph in part a), describe in details on the effect of lower export on the equilibrium in the short run, labelling the new equilibrium output and price level Y2 and P2, respectively.

c)Based on your result in part b), what is the impact of lower export on real wages in the short run? Explain.

d)Show, with a new graph,how the economy will return to its new equilibrium in the long run if the government does not intervene. Explain.

e)Suppose the government decides to increase expenditure on new equipment.(i)What component of aggregate demand will change?Explain.(ii)What is the impact on the long-run aggregate supply? Explain.

The total word count of all questions should be 500 words .

Please help !!!

Answer 1

(a)

In graph below, AD1, LRAS1 and SRAS1 are initial aggregate demand, long-run aggregate supply and short-run aggregate supply curves intersecting at long-run equilibrium point A, with initial equilibrium price level P1 and real GDP (= potential GDP) Y1.

(b)

Lower exports decreases net exports. A fall in net exports decreases aggregate demand, shifting AD curve leftward, decreasing both price level and real GDP in short run, creating a recessionary gap.

In above graph, when net exports decreases, AD1 shifts leftward to AD2, intersecting SRAS2 at point B with lower price level P2 and lower real GDP Y2. Recessionary gap is (Y1 - Y2).

(c)

Since nominal wage remains the same in short run, but price level decreases, real wage increases.

(d)

In the long run, a fall in price level will decrease prices of inputs, raising production costs. Firms will increase production, increasing aggregate supply. SRAS shifts rightward, intersecting new AD curve at further lower price level and real GDP being restored to the potential GDP.

In graph below, in long run, SRAS1 shifts right to SRAS2, intersecting AD2 at point C with further lower price level P3 and restoring real GDP to potential GDP level Y1.

(e)

(i) Higher government expenditure on new equipment is a component of Government spending on goods and services. This will increase aggregate demand.

(ii) Higher investment on equipment will increase total stock of capital in future (since investment is a source of capital accumulation), increasing potential GDP. The long run aggregate supply curve will shift rightward.