Question

Explain why Coronavirus and the ensuing recession is a demand shock rather than a supply shock. Use current inflation and unemployment data to make your case.

Answer 1

Demand shock

A demand shock is a sudden and surprise event such as this COVID-19 pandemicthat dramatically increases or decreases aggregate demand(C+I+G+NX) for goods or services, usually on a temporary basis.

Keynes maintained that unemployment is the result of inadequate demand for goods. During the Great Depression, factories sat idle, and workers were unemployed because there was not enough of a demand for those products. In turn, factories had insufficient demand for workers. Because of this lack of aggregate demand, unemployment persisted and, contrary to classical theories of economics, the market was not able to self-correct and restore balance.

The current unemploment figures in some of the countries are Spain-13.6%,France-8.2%, US-3.5%, UK-3.2%. These figures are likely to increase as firms begin to lay off workers in response to the fall in sales and revenues. Inflation figures are likely to fall due to decrease in demand for goods which will make prices fall. As evident in India where inflation dropped from 7% to 5.66% due to fall in demand. Consumers become apprehensive of the uncertain future ahead and thus increase their saving.

However the current recession may also have supply side features due to global lockdown.