Question

The Covid-19 crisis and subsequent 21-day lockdown has been a supply-side shock to the South African economy. In response, the Reserve Bank has announced a number of policy interventions to help cushion the blow.

Use the AD-AS model, in conjunction with the IS-LM-BP, to explain the supply and demand dynamics of the shock and policy response.

Draw the graphs and explain the complete chain reaction

Answer 1

The Covid-19 crisis and subsequent 21-day lockdown have been a supply-side shock to the South African economy. so the Reserve Bank has announced a number of policy interventions to help the economy sustain.

Here in the given figure to avoid the complexity we are assuming the initial points as AD and AS1 and AS2. when there is a shock in supply-side AS will go up to AS2 again after policy intervention, again it will come back to its original position. So our first or the initial position in the AD-AS model is A where the same in IS_LM-BP model os E. here there is no shock. getting shocked the points have been changed as the supply got affected so supply shifted to AS2 and the point got changed B with that the price changed to P2 from P1 and income/output decrease from Y1 to Y2. at the same flow the IS-LM-BP also got affected as the initial equilibrium point was E and after change in supply the IS curve shift to leftwards and the new equilibrium point is F with a low-interest rate and low income/output.

Now when the government will propose some policies (Fiscal and Monetary) to push the economy will again pull the AS curve back to the original position and there is restore of price, interest rate, and income back to the original position.

here to avoid the complexity of the diagram, we are assuming the restoration is exactly the loss amount. But in reality, it is less than the original one.