Question

Coronavirus pandemic and resultant shutdown measures to contain it have plunged the economies around the world including Singapore into severe contraction. Assuming Singaporean economy was in long run equilibrium in the aggregate demand and supply (AD-AS) model before the pandemic (and consequent shutdown) started, answer the questions below:

1. Assuming the contraction in the Singaporean economy is mainly driven by demand side factors, Show the short-run effects of this using the AD-AS model. Carefully explain in words (100 or less).

2. Now assume that the contraction in the Singaporean economy is mainly driven by supply side factors, Show the short-run effects of this using the AD-AS model. Carefully explain in words (100 or less).

3. Which of the above mentioned two recessions scenarios, is more challenging for the policy makers to deal with (the government and the central bank)? and why? (explain in 50 words or less) (hint: think about the trade-offs in policy responses).

Answer 1

(a)

In the above image as you can see the original AS curve is given by AS line and the original AD curve os given by AD line. And the initial equilibrium was at point A where equilibrium output was at Q* and the equilibrium price level was at P*. As mentioned in this part that the contraction in the singapore economy was due to ide factor. So the contraction due to demand side is shown by the leftwards shift in the D curve, the new AD curve is shown by the dashed line named AD'. And as you see the new equilibrium is at point B where the equilibrium output is at Y' and the equilibrium price level is at P'. As you see the new equilbrium price level is lower than the previous eqilibrium price level and the output is also lower than the previus output level.

(a)

In this part we are told that the contraction in the singapore eonomy is due to the supply factors. So the contraction in the economy due to supply factors is shown by the upwards shift in AS curve, as you can see in the above figure the AS curve shifts upwards to AS' show by the dashed line.The new equilibrium is at point B where the equilbrium output is at Y' and the equilibrium price level is at P'. Notice that in case of supply side contraction the equilibrium price level increases as output falls, which is quite clear from the above figure.

(a) The more challenging scenario for the policy makers is the second one in which the contraction is due to the supply side this is because the policy makers can affect the aggregate demand that is AD but the policymakers can't directly affect the AS. The AD can be affected by the government directly through G component of AD or the central bank can affect the investment by lowering the interest rates but the policymakers don't have direct control over supply which is determined by the labor market.