Explain graphically the impact of COVID-19 (an epidemic disease creating a recessionary gap) on the real...

Explain graphically the impact of COVID-19 (an epidemic disease creating a recessionary gap) on the real GDP of a Country “X” assuming the Keynesian model of Aggregate Demand and Kenyesian Aggregate Supply curve. Also provide a solution to this crisis of the economic recession.

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Expert Solution

Keynesian model of aggregate demand and aggregate supply draws the downward sloping aggregate demand function. The aggregate supply function is horizontal for fixed prices till the potential GDP is reached and then it becomes vertical at potential GDP. Together they determine the real GDP in the economy.

Now there is a recessionary gap created in the economy (Y1-Y2) as a result of leftward shift of the aggregate demand curve (AD2 from AD1). In order for the economy to return to its potential GDP level the aggregate demand must increase and aggregate demand curve should shift to the right.

This can be done by increasing the government expenditure and / or reducing the personal income taxes / corporate taxes. This is a part of Fiscal expansion. It is likely to increase consumption and investment and therefore aggregate demand will increase and the recessionary gap will be eliminated

Rahul Sunny answered 1 year ago

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