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In: Economics

What is the impact of coronavirus on aggregate demand…will it have an impact primarily on aggregate...

What is the impact of coronavirus on aggregate demand…will it have an impact primarily on aggregate demand or aggregate supply or both? Explain

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Expert Solution

Aggregate demand basically includes Consumption , Investment , Government expenditure and Net exports . During Covid 19 , there is a lack of confidence among consumers in the market , morover there is a massive fall in investment and plunging of Net exports . However Government expenditure on Health may rise , but that is too low to deal with the fall of other three main components. Hence there is no doubt that Aggregate demand will be negatively effected .

COVID-19 has had clear supply effects: quarantines, closed factories, supply chain disruptions and impaired mobility obviously affect production. The effects on demand are more difficult to gauge but it is critical from an economic policy point of view to get a sense of them because we have more confidence about how to deal with demand (through monetary and fiscal tools) than with supply deficiencies.

Changes in real goods prices can indicate whether COVID-19 is causing major demand effects. Specifically, if aggregate supply effects dominate demand effects, we should see prices going up as activity goes down, in a kind of repeat of the stagflation of the 1970s. At that time, central banks were in a dilemma about whether to increase rates to fight inflation or to reduce rates to support economic activity. If prices remain largely unchanged, we can conclude that aggregate demand has also been substantially negatively affected by the spread of the virus.

Hence we can conclude that both curves are badly affected .


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