Question

Using the aggregate demand and aggregate supply (AD-SRAS) framework, explain how a large-scale natural disaster would be expected to impact the economy. (Take the economy through the steps from equilibrium to disequilibrium to equilibrium using the AD-SRAS framework.) Discuss how an economist who believes the economy is self-regulating would view the longer term impact of such a disaster, and whether they would advocate the need for government intervention.

Answer 1

Natural disaster will reduce the aggregate supply of goods such as crops, manufacturing items etc. It will shift supply curve to its left from SRAS to SRAS1 while AD remains the same, it will result in rise in price from P to P1 and output level to fall from Y to Y1. It will shift the economic equilibrium point from E to disequilibrium point E1.

If the economy is self regulating, aggregate demand will fall because consumers will not be in state of buying goods at higher prices and shift demand curve to its left from AD to AD1. It will take price to its initial level and lower output level further.

Self regulating economy will reduce output level which makes government intervention very necessary in short run before aggregate demand falls. Government can provide raw food to people, insurance to farmers, homes to people who lost it in disaster and much more.