Question

In this question we will reflect on the Australian fires from last year. A wide part of Australia has experienced severe fires in the last year, which made the economy much less productive and had severe impacts on business activities.

1. a) Explain why you could expect negative shifts in the aggregate demand curve following the fires. What would you expect are the drivers of this shift? Reflect on each of the components of the aggregate demand and comment on whether they are likely to change due to the fires. [6 marks]

2. b) Explain why you could expect negative shifts in the aggregate supply curve following the fires. What would you expect are the drivers of this shift? Reflect on each of the components of the aggregate supply and comment on whether they are likely to change due to the fires. [6 marks]

3. c) Show the shifts discussed in parts a) and b) graphically. You may assume an upward sloping AS curve for simplicity. Can you predict what happens to real GDP and the price level? [8 marks]

4. d) The fires in Australia can also be considered a decrease in the country’s stock of capital. You may use the Solow model to show what happens when capital decreases and what the model predicts for the new growth rate. Are these con- sequences likely to happen in practice? [10 marks]

Answer 1

a) Australian wildfire has an impact on its economy. it is 0.4%, which includes the major agriculture, tourism directly whereas the environment related to other aspects indirectly. so if we take the aggregate expenditure of Australian consumers decrease for a short period of time. so we can expect a decrease in aggregate demand shift left which shows a decrease in quantity consumption and the price of the products majorly agriculture-related products increased. so a decrease in aggregate demand for the short-run is true for Australia.

b) Australian wildfire also affects the aggregate supply directly. if we take the wooden furniture supply or tourism it has a direct impact on it. the agricultural product supply also got decrease in the short run. due to the heat, there is low rainfall and the moisture of the land got decreased. the quality and quantity of agricultural goods got decreased. cattle farming got impacted at 2%. so the overall impact on aggregate supply is negative.

c) The overall impact of Australian wildfire has an impact on both aggregate supply and aggregate demand. both impacted negatively and shifted left. so the quantity supply and demand both decreased. Due to the loss, the supply of agricultural product prices also raised up.

d) if we will consider the Solow growth model then due to the rescue and resettlement of wildfire losses government has spent a huge amount so if we will take that as the decrease in capital stock then the K* capital per worker will come down to K1 and that has an impact on the output per worker or on investment per worker which will come down from Y* to Y1. These consequences are definitely these in a negative but as it is only 0.45 of GDP it may not impact the growth that seriously and this impact can be assumed for a short period of time but in long run, the growth will be back to the potential level.