ECS3709
Assignment 3
Semester 2
2024
, QUESTION 1
To evaluate the effects of temporary demand shocks experienced during the COVID -
19 outbreak using the Aggregate Demand and Aggregate Supply (AD-AS) model, we
can consider the model's standard equilibrium before and after the shocks.
Graphical Representation
Initially, we have an AD-AS model with an upward-sloping Aggregate Supply (AS)
curve and a downward-sloping Aggregate Demand (AD) curve. The intersection of
AD and AS determines the equilibrium level of outpu t (Y) and the price level (P).
• Initial Equilibrium: Point E1 (P1, Y1)
When the COVID-19 pandemic hit, several factors contributed to temporary demand
shocks, including reduced consumer spending, increased savings rates due to
uncertainty, job losses, and decreased business investments.
1. Decrease in Aggregate Demand: The initial impact of the COVID-19
pandemic led to an outward shift of the AD curve to the left from AD1 to AD2.
This reflects decreased consumer and business confidence, leading to
reduced expenditure in the economy.
2. Impact on Price Level and Output: The shift in AD from AD1 to AD2 results
in a new equilibrium at E2, represented by a lower price level (P2) and lower
output level (Y2).
o Price Level (P): The decrease in demand leads to a downward
pressure on prices, reducing the overall price level from P1 to P2.
o Output (Y): The output also declines from Y1 to Y2, indicating that the
economy is operating below its potential output.
o Employment: As output decreases, firms may respond by reducing
their labor force, leading to higher unemployment rates.
Economic Explanation
• Impact on Prices: The leftward shift of the AD curve results in a decrease in
aggregate demand. According to the AD-AS model, this results in lower price
levels as firms respond to reduced demand by lowering prices.
• Impact on Output: The reduction in aggregate demand causes firms to cut
back on production, leading to a decrease in overall output in the economy.
This can be explained by firms facing lower sales, which compels them to
adjust their production levels downward.
• Impact on Employment: With output decreased, firms often respond by
laying off workers or freezing new hires, leading to increased unemployment
in the economy. This not only results in a loss of income for the affected
Assignment 3
Semester 2
2024
, QUESTION 1
To evaluate the effects of temporary demand shocks experienced during the COVID -
19 outbreak using the Aggregate Demand and Aggregate Supply (AD-AS) model, we
can consider the model's standard equilibrium before and after the shocks.
Graphical Representation
Initially, we have an AD-AS model with an upward-sloping Aggregate Supply (AS)
curve and a downward-sloping Aggregate Demand (AD) curve. The intersection of
AD and AS determines the equilibrium level of outpu t (Y) and the price level (P).
• Initial Equilibrium: Point E1 (P1, Y1)
When the COVID-19 pandemic hit, several factors contributed to temporary demand
shocks, including reduced consumer spending, increased savings rates due to
uncertainty, job losses, and decreased business investments.
1. Decrease in Aggregate Demand: The initial impact of the COVID-19
pandemic led to an outward shift of the AD curve to the left from AD1 to AD2.
This reflects decreased consumer and business confidence, leading to
reduced expenditure in the economy.
2. Impact on Price Level and Output: The shift in AD from AD1 to AD2 results
in a new equilibrium at E2, represented by a lower price level (P2) and lower
output level (Y2).
o Price Level (P): The decrease in demand leads to a downward
pressure on prices, reducing the overall price level from P1 to P2.
o Output (Y): The output also declines from Y1 to Y2, indicating that the
economy is operating below its potential output.
o Employment: As output decreases, firms may respond by reducing
their labor force, leading to higher unemployment rates.
Economic Explanation
• Impact on Prices: The leftward shift of the AD curve results in a decrease in
aggregate demand. According to the AD-AS model, this results in lower price
levels as firms respond to reduced demand by lowering prices.
• Impact on Output: The reduction in aggregate demand causes firms to cut
back on production, leading to a decrease in overall output in the economy.
This can be explained by firms facing lower sales, which compels them to
adjust their production levels downward.
• Impact on Employment: With output decreased, firms often respond by
laying off workers or freezing new hires, leading to increased unemployment
in the economy. This not only results in a loss of income for the affected
