Question

Over the last month or so, the value of stocks have fallen because of the corona virus? Which determinant(s) of aggregate demand are affected when the value of stocks fall? How has the drop in the value of stocks affected the aggregate demand curve?

Answer 1

Due to corona virus outbreak, people want to hoard their money in a safe form which will not fall in value in near future, this form is mostly cash and demand deposits. So, people are selling the stocks they own in the stock market, increasing their supply which pushes the stock prices down. Now as people are pessimistic, so, they have increased the demand for money (in the form of cash and demand deposits) and reduce their consumption and private investments (they start to save for the uncertain future). This decrease in consumption and private investment leads to a leftward shift of the IS curve. This leftward shift in IS curve leads to a leftward shift in AD curve which leads to a fall in real output and price level. This creates a recessionary condition in the economy. Now, the government can pull out the economy from this condition by increasing liquidity in the economy i.e. monetary expansion, this will lead to fall in interest rates due to rightward shift of LM curve and fall in interest rates. Also, bailout packages to failing industries will be required for increasing private investment again. Thus, a fiscal expansion along with monetary expansion will be required to bring the economy back to track.

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