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In: Economics

In Tutorial 4 we discussed what impact Covid-19 would have upon output in a simple Keynesian...

In Tutorial 4 we discussed what impact Covid-19 would have upon output in a simple Keynesian model. In this question, we extend this analysis by examining the impact of Covid-19 in the context of the AD-AS model.

a) Suppose Covid-19 reduces the exogenous component of consumption (C), planned investment, IP and exports X. What impact will this have upon the position of our AD andAS curves. Explain your reasoning by using a diagram.

b) Explain how the macroeconomy would adjust to the Covid-19 shock (as described above) in the long run if there was no change in the monetary policy reaction function or fiscal policy in response to the pandemic. Explain your reasoning using a diagram.

c) In response to the pandemic, the government has pursued a policy of increasing payments to unemployed individuals (ie. Jobkeeper). In addition, it has foreshadowed a reduction in taxes in the October budget update. Explain what impact these policies will have upon the macroeconomy with reference to the AD-AS model.

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This time world is facing a pandemic due to Corona virus. Due to this pandemic the economy has affected worst. All the major economic or social activities affected worst. The major industry that have affected by this pandemic are- aviation, tourism, retail, trading, construction retail etc. During this pandemic million of people have lost ther jobs and thousands of people lost their lives. During this pandemic the major economic indicators GDP, unemployment, inflation,fiscal deficit etc. have getting worst day to day.

AD is affected by the following factors- consumptions, investment, government spending, net export. If these factors increase AD increase . When AD increase its crease output and price level and vice-versa. Other side AS is affected by production cost, commodities prices, government policy, price level, future forecasting etc

a). Answer:

Suppose COVID-19 reduces the exogenous component of consumption (C), planned investment, IP and exports X

If C, IP and  X decrease due to COVID-19 then it will decrease AD and AD curve will shift left or inward. Suppose the economy is equilibrium at the equilibrium point "E' and now due to COVID-19, C, IP and  X decrease and its decrease AD and AD curve shift left from AD to AD1. At this level the new equilibrium point is E2. At this equilibrium point the price level and output both decrease from P to P1 and Q to Q1 respectively.

Graph:

b)

Due to COVID-19 the AD affected worst and it will decreased AD and decreasing AD will decrease output and price level both. Decreasing price level and output level will decrease the confidence level of investors (producers) that will decrease investment and production level that will increase unemployment level and decrease income level. Decreasing income level will further decrease AD that will decrease output and price level and the economy will inter into the deep recession. If the policy making authorities do not take any relevant actions then the economy will fall into a great recession and affect the nation worst. It the government and the central bank do not take action then it will reduce AD and AS further. So, both the AD and AS will decrease in the long run. It will shrink the economy deeply and increase unemployment level and economy may face the problem of deflation. Due to decreasing AS or short supply price may increase that may increase inflation.

Suppose the economy is equilibrium at the equilibrium point "E' and now due to COVID-19, C, IP and  X decrease and its decrease AD and AD curve shift left from AD to AD1. At this level the new equilibrium point is E2. At this equilibrium point the price level and output both decrease from P to P1 and Q to Q1 respectively. Now in long run the AS decrease and shift SRAS to SRAS1. At the new equilibrium point E3 the price level increase from P to P2 and output is till maintain at previous level (Q1).

Graph:

c)

If the government has pursued a policy of increasing payments to unemployed individuals (ie. job keeper). In addition, it has foreshadowed a reduction in taxes in the October budget update then it will increase the income level of the people and it will increase consumption level. Consumption level contribute for more than 60% in AD and AD will increased. Increasing AD will increase output and price level. Increasing output and price level will boost the economy and increase production level. Increasing production level will increase income level and decrease unemployment level that will further increase AD and boost economic growth.

Here increasing payments to unemployed individuals and taxes cut increase AD and AD incraese from AD to AD1 that increase output and price level from Q to Q1 and P to P1 respectively.

Graph:


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