Question

In the event of an outbreak such as coronavirus there is a loss in the production of goods and services due to fear of contraction. Assuming no exogenous variables changes in the economy, using the four standard AS/AD models show the response of the economy to the loss in technology

Answer 1

Corona pandemic will cause recessionary cycles as aggregate demand will go down. People will be unsure of earnings in future and will save more. Loss of technology will lead to shift in aggregate supply to the left and it might raise price levels. In my opinion loss of demand will be the key factor and price levels will not go up much.

Aggregate supply may shrink for a while but will resume when normalcy returns.

Effect explained:

Aggregate supply will shift to the left as many production facilities will be closed or will produce less due to lockdown. Manufacturing hubs of the world is able to export less and hence overall aggregate supply shifts left causing real GDP to decrease and average prices to go up causing stagflationary impact as shown below. price levels go up from P1 to P2 and real GDP goes down from y1 to y2.

As shown above, aggregate demand shifts left from AD1 to AD2 as many people lose jobs and consumer and business confidence is low in an economy. Recession is when real GDP growth is negative for six months. This causes real GDP to be low and price levels to go down.Average prices will be determined by AD and AS curves. If AD shift to left is stronger than AS shift to left then average prices will be less and if AS shift to left is stronger then average prices will be high.

Economy will correct as aggregate supply and aggregate demand come back to long run aggregate supply level of AD1-AS1 due to cheaper factors of production and more jobs produced in the long run. Reason for this will be flexible wages will decrease wages and shift aggregate supply right and also slow but steady growth will shift aggregate demand right.