Question

Assume the Canadian economy is at the equilibrium with output ?? and price ?? and then the COVID-19 shock hits the economy. Study the possible impacts of this shock on the following cases of the economy:

Demand Side (AD): (1.5 points)

a) What is the effect of COVID-19 shock on the IS curve (Note: start with the impacts on the Keynesian cross and then explain the impact of the shock on the IS curve.) Support your analysis with corresponding graphs.

b) Assuming the price is still ??, what will be the impact of the shock on the AD curve? Briefly explain your answer using a corresponding graph.

c) How can the government alleviate the negative effects of the shock on the AD curve? Briefly explain your answer by using just one example.

Supply Side (SRAS): (2 points)

d) What is the impact of the shock on the SRAS curve? Draw the graph. Support your answer using a real example.

e) What kind of policy can the government implement to alleviate the negative impact of the shock on SRAS?

f) What are some side-effects of these policies (parts c and e ) on the economy? Briefly explain.

g) What will be the new equilibrium of the economy if the government does not intervene? Draw AD and SRAS curves for before and after the shock in one graph.

Money: (1.5 points)

h) According to the portfolio theories of money, what are the factors that affect the demand for money? How they affect the demand for money? Briefly explain.

m) Considering the portfolio theories and given Figure 1 that shows the stock price in Canada. Do you think that the demand for money will decrease or increase? Why?

n) Following the COVID-19 shock, the Bank of Canada announced that they want to purchase the government’s bonds in the secondary market. Given the function of the supply of money (M=cr + 1cr + rr B) and considering your answer for part h, do you think that the supply of money will increase/decrease/or uncertain? How? Explain your answer briefly.

Answer 1

a. Because of the COVID 19, Canadian government had to lockdown due to which people are supposed to stay home only. Also, production in many businesses has stopped. Due to this, the consumption and investment expenditure has been affected. People can no longer go out on movies, eat out or shop. This has reduced the aggregate demand in the economy. Also, there is no new investment happening due to backlog. Thus, this has furthus reduced aggregate demand.

In the Keynesian cross, this effect can shown by the downward shift of the AD curve which furthur reduces the equilibrium level of income in the economy.

This reduction can also be shown by the backward shift of the IS curve.

b. At the given price level, the AD Curve will shift backwards because of the decline in economic activity. Thus, at the given price level, the quantity demanded reduces. This forces the prices downward. Thus, the quantity demanded increses until the AD curve finally intersects the AS curve at the new equilibrium.

c. Government can allevate the negative effects by increasing the expenditure in the economy. This can be done by transferring the purchasing power to the lower sections with no source of income during lockdown.

d. COVID 19 has affected the manufacturing processes due to the lockdown. Workers are unable to go to their jobs because of the pandemic. Exports have reduced. All this has shifted the supply curve in the backward direction.