Activity 6(c)

Activity 6c The immediate AD and AS effects of COVID-19

  1. The virus itself caused widespread panic across society which typically increased consumers’ propensity to save (which necessarily resulted in a reduced propensity to consume and/or spend) and also resulted in a huge decrease in both consumer and investor confidence. This reduced both consumption and investment demand, decreasing aggregate demand.
  2. The virus resulted in a reduced supply of key inputs from China due to manufacturing closures (in response to illnesses and shutdowns) which added to the costs of production. In addition, stay at home orders and lockdown measures introduced across Australian states resulted in reduced rates of productivity at many businesses, raising the effective cost of production for these businesses and reducing the ability of businesses to supply goods and services to markets (i.e. decreasing aggregate supply)
  3. The policy initiatives that were designed to slow the spread of the virus (i.e. physical/social distancing and lockdown measures) restricted the ability of consumers to spend (e.g. shopping at physical retail outlets) which reduced AD. But the government measures also had an immediate negative impact on the ability of numerous businesses to supply goods or services to markets (as labour input and productivity were both negatively affected and there were constraints on the operating hours (and types of service) that could be provided by many businesses (e.g. restrictions on cafes and prevention of sporting, cultural, entertainment services), which caused the AS curve to shift to the left.
  4. This occurred because the government provided a huge increase in income support measures (Jobkeeper and Jobseeker – coronavirus supplement) that more than offset the original reduction in disposable incomes.
  5. This Occurred because the uncertainty resulted in a huge increase in the propensity for households to save rather than spend, causing the household savings ratio to climb from 6% to 20% in the June quarter
  6. This is because the falls in AD were so significant, that they more than offset the increase in prices that otherwise would have stemmed from a reduction in aggregate supply.