Question

The COVID-19 pandemic, and associated public health responses such as shutdowns, can be thought to include both a negative supply shock, and a negative demand shock.

Excerpt from article

Supply and demand and the COVID-19 shock

COVID-19 has had clear supply effects: quarantines, closed factories, supply chain disruptions and impaired mobility obviously affect production[1]. 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.

Your Task:

Read the excerpt above (you may want to read the full article for context or for your own interest, but you do not need to refer to the additional content there).

Use the AD-AS model, including your own diagram/s, to explain why looking at prices would be a useful way to compare the relative magnitudes of the supply shock and demand shock.

Do i need to consider in the long run equilibrium or in the short run equilibrium?

Answer 1

Hi,

Hope you are doing well!

Question:

Answer:

We have seen how the economy has get affected due to COVID-19 pandemic. This time the economy has get affected worst and GDP growth shrunk worst and unemployment have increased rapidly. Inflation is very low and fisacl deficit increased. AD- AS model shows the impact on price and output and due to change in AD and AS. AD is directly affected by consumption, investment, govenment spending and net export. Other side AS is affect by input cost, commodities price, change in technology and government policy, political, social oe economic distruption etc. Normally when AS is unchaged, increase AD incraese price level and output level and vice-versa. Other side if AD is unchaged, increasing AS increase output and decrease price and vice-versa. Here shock may be positive or negative. Negative demand and supply shock means decreased AD and AS rapidly respectively.

Here i will see the short term effect of shocks:

Graph:

Here positive demand increase AD and AD curve shift right from AD to AD1 and its increase price and output level.

Here negative demand shock decrease AD and AD curve left right from AD to AD1 and its decrease price and increase output level.

Here negative supply shock decrease AS and AS curve shift left from AS to AS1 and its increase price and decrease output level.

Here we can see the economy is in long run equilibrium and a negative demand shock decrease AD and demand curve shift left from AD1 to AD2  that decrease price level and decrease output level.

So, here in the above mentioned graphs we can see why looking at prices would be a useful way to compare the relative magnitudes of the supply shock and demand shock.Any shock directly affect to the price level. We should consoder in the short run equilibrium. You can also suppose, the economy is in long-run equilibrium and how shock will affect the price level and output level in short-run.

Thank You