Question

According to the aggregate demand and aggregate supply model, what have been the effects of the Corona Virus on the US economy?

Answer 1

The COVID19 crisis has been scrutinised from economic view point by economists all over the world. One consensus that has emerged regarding the Aggregate Demand and Aggregate Supply is that both have suffered negative shocks.

• Negative supply shock: The negative supply shock is driven by many reasons:

(i) Raw material: Major industries in the US relied on raw materials from Asian countries like India and China which has stopped largely because of restrictions on mobility and fear of China's role in the outbreak. Thus, the forward supply chain has stagnated.

(ii) Labour mobility: Labour mobility both inside US and from outside the country has stopped because of restrictions.

(iii) Financial disruption: Easy credit availability has become an issue as investors are parking their money in risk averse assets like treasuries and gold. This is reducing pool of funds available to the corporates for capacity building.

(iv) Non functioning: Apart from essential industries, most firms are operating at low capacities or have shut down.

• Negative demand shock:

(i) Lockdown has imposed restrictions on mobility of consumers who aren't venturing out to make purchases in the market. This is the primary cause of reduced demand.

(ii) Low consumer demand has also lowered demand for raw materials by intermediate producers as the final demand has worn out.

(iii) Companies have laid off or reduced compensation for workers, thus causing budget constraints to the consumers who aren't able to buy in the market due to reduced purchasing capacity.

The negative shocks on both fronts have come together to reduce equilibrium quantities traded in the market. In general, demand has been hit with a greater magnitude, thus prices have also reduced.

Graphically,

The equilibrium quantity falls from Q1 to Q2 and equilibrium price from P1 to P2.

Please note that this is the aggregate of all goods in the economy. If goods were to be divided into essential and non essentials, then story would be a bit different. Essentials would not undergo much of a difference, rather a temporary spike even, due to increase in healthcare costs. But non essentials will face the negative consequences regardless.

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