Question

Provide an argument that justifies the 'COVID-shock' as a 'demand' shock.

Provide an argument that justifies the 'COVID-shock' as a 'supply' shock

Suppose that you have data available on aggregate output and the aggregate price level, P, for the months following the COVID shock. What association between these two might reveal that the COVID-shock is a predominantly a demand shock or predominantly a supply shock?

Answer 1

COVID-shock can be considered as a demand shock because it has resulted in massive layoffs due to which there are are job losses and when people do not have income to spend they will reduce consumption. Investment has also declined because of the gloomy economic outlook and both of these reasons are going to shift the aggregate demand curve to the left resulting in a demand shock

COVID-shock can be considered as a supply shock because there has been a reduction in the production of most goods and services because of lack of investment. Because of restrictions in the supply chain management due to the lock down there has been a reduction in the production capacity. This indicates that the aggregate supply curve will be shifting to the left resulting in a supply shock

Note that if the COVID-shock is a demand shock then aggregate output and aggregate price level both should decline and there should be a positive relationship. However if it is a supply shock then aggregate output should decline and price level should increase which means there should be an inverse relationship between the two