Question

Due to the ongoing pandemic 2 features have affected every economy.

• Average health condition has deteriorated. Which of the curves will be affected and in which direction? Explain your answer.
• Due to staggered progress of research and development, productivity of resources has been adversely affected. Which of the curves will be affected, in which direction? Explain your answer.
• Use a new well labeled graph and show clearly the changes to the equilibrium condition based on the above 2 features. Your graph must clearly show the change in the new equilibrium as a result of combination of both the features occurring simultaneously.

Answer 1

Deterioration in the health condition of the people has affected aggregate demand in the economy. This is because it has reduced income level of consumers and this has decreased consumption and investment expenditure by consumers and investors because of negative consumer and business investment in the economy. Reduction in consumption and investment expenditure in the economy and reduced aggregate demand in the economy and shifted the AD curve leftwards to AD'.

On the other hand, due to staggered progress of research and development, productivity of resources has been adversely affected. This has reduced the level of aggregate supply in the economy bot in the short run as well as long run. Due to this the SRAS and LRAS has shifted leftwards to SRAS' and LRAS' and thus new equilibrium in the economy occurs at point E2 where actual level of real GDP in the economy has decreased to OY' and impact on prices is ambigious as it depends on the magnitude of the shift of AS and AD curves. This can be depicted as:

Thus, it can be stated that the ongoing pandemic has reduced the level of output in the economy and new output at potential level is less than potential level in the intial equilibrium.