Question

Question 1: At the start of the COVID-19 pandemic, the Canadian (and global) economy suffered quickly from a decline in the volume of trade to China. For example, Air Canada quickly discontinued all direct flights to China following the federal government's advice to avoid non-essential travel.

Using the aggregate supply and demand model (OA-DA), rigorously describe the impact of the shock described above on the initial equilibrium of the Canadian economy.

Answer 1

Aggregate Demand = Consumption + Investment + Government Spending + Exports - Imports

Due to COVID-19, trade are temporarily banned, consumers can buy goods stored or made in Canada. As a fall in imports raises aggregate demand but fall in consumption and Investment is so high that it will surely over weigh the fall in imports which tends to reduce the aggregate demand in the economy and shift aggregate demand curve to its left from AD to AD1 which reduces the price level in the economy from P to P1 and reduces output level to Y1 from Y.

Aggregate supply will also fall because many factories, firms are temporarily shut or some use raw material which comes from China. It will reduce the aggregate supply in the economy from AS to AS1. It will raise price again to its initial level and reduce output level further to Y2.

This will be the case only if Canada is self sufficient to supply enough goods to feed their population. If Canada is reliant on China for food, trade ban will raise food prices due to scarcity.