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IAI Actuarial Core Principles · Business Economics · Recent macroeconomic history

In 2020, many economies experienced the COVID-19 shock as a combined disruption to both supply (lockdowns, factory closures) and demand (reduced spending on contact-intensive services). Which statement best describes the likely effect on the general price level and output if the supply fall and demand fall were both large?

Output falls for certain because both the supply and demand shocks reduce it. The price level is ambiguous because the supply shock pushes prices up while the demand shock pushes them down, so the net result depends on which shock is larger.

  1. AOutput falls with certainty, while the effect on the price level is ambiguousCorrect
  2. BOutput rises and the price level falls with certainty
  3. COutput is unchanged and the price level rises with certainty
  4. DOutput falls and the price level rises with certainty
  5. Output rises with certainty, while the effect on the price level is ambiguous

Explanation

A fall in aggregate supply shifts the curve left, raising prices and lowering output. A fall in aggregate demand shifts the curve left, lowering both prices and output. Both reduce output, but their price effects oppose each other, so the net price change depends on relative sizes.

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