Answer to Question #194307 in Macroeconomics for Fahad

Question

By using AD-AS Model, discuss the impact of prevailing COVID-19 situation on Pakistan’s economy in terms of; {Note: make neat and clean diagram to explain the followings}

a. Real GDP                                      

b. General Price Level

c. Inflation

d. Unemployment

e. Briefly suggest Fiscal Policy or Monetary Policy Measures or Mix of Both to minimize the effects of this pandemic situation?

Answer 1

The economy is in long-run equilibrium when the aggregate demand curve, short-run aggregate supply curve, and the long-run supply curve intersect, at point A in the figure below. The covid-19 pandemic has resulted in a considerable fall in the income levels of the consumers and the businesses, which will reduce the consumption and investment spending in the economy. The fall in consumption and investment spending will result in a leftward shift of the aggregate demand curve from AD to AD1. The increase in the input prices has also resulted in a leftward shift of the short-run aggregate supply curve from SRAS to SRAS1, moving the economy from point A to point B in the figure below.

a) The leftward shift of the aggregate demand curve and short-run aggregate supply curve results in a fall in the real GDP from Y to Y₁. 

b)When the aggregate demand curve shift to the left, the general price level in the economy falls, and when the aggregate supply curve shift to the left, the price level increases. As the supply shock was greater in magnitude than the demand sock, the price level in the economy has increased from P to P₁

c) Inflation refers to an increase in the general price levels in an economy over a given period of time. The increase in the price level in the economy indicates an increase in inflation rates also.

d)When the economy moves from point A to point B, it deviates from the full employment level of GDP, Y. The fall in the real GDP from the potential level or from the full employment level indicates an increase in the unemployment rate.

e) Expansionary monetary policy or expansionary fiscal policy or the combination of both will help to minimize the impacts of the pandemic. A tax cut or increase in government spending will increase the aggregate demand in the economy. A reduction in the interest rate will also increase the consumption spending and investment spending in the economy, resulting in an increase in the aggregate demand. The increase in aggregate demand will increase the real GDP and employment in the economy.