performance, as the UK knows only too well.’
11 Using at least one example of each, explain how demand-side and supply-side shocks
might harm a country’s economic growth.
Economics growth is an increase in equilibrium nation output in an economy over the period. Economic shock is an unexpected event or one that at least some had predicted which affects an economy either positively or negatively.
Negative supply side shock is an unexpected event that causes a reduction in aggregate supply and it is caused by unexpected increase in costs of production that are significant enough to affect the whole economy for example an increase global oil prices which will cause the economy’s overall productivity to decrease causing cost push inflation and reduction in economic growth. Oil prices will directly affect the cost of production of products that are significant enough and it will affect indirectly the manufacturing and transportation because the prices of oil and gasoline are closely related. Producers will pass the high costs of production onto the consumers via increasing the prices. This will shift the SRAS to the left from SRAS1 to SRAS2 increasing the price levels of oil from PL1 to PL2 as well as decrease in national output from Y1 to Y2 which results in stagflation, which means reduction in economic growth and inflation. These high costs of production will increase unemployment since there will higher nominally wages for employees so firms cannot afford as many workers anymore.
Another supply side shock that can cause a decrease in economic growth and harm the economy is a natural disaster taking place in a country such as COVID-19 pandemic which slowed the production of many firms as the health crisis spread. This disaster led to low producer and consumer confidence and rise in unemployment as many non-essential industries forced to be closed or adapt to work from home. Many firms made their workers redundant due to the high costs of production and could not afford labour wages, since there was fall in demand for labour resulting in fall in demand for goods and services. This shift SRAS to left from SRAS1 to SRAS2 increasing the price levels of labour from PL1 to PL2 as well as decrease in national output from Y1 to Y2 which results in stagflation, which means reduction in economic growth and inflation. These high costs of production will increase unemployment since there will higher nominally wages for employees so firms cannot afford as many workers anymore.
Similarly, negative demand side shock is either internal or external which result in aggregate demand to fall for example 2008 financial crisis which lead to global credit crunch and led to a prolonged period of negative growth, rising unemployment, and reducing economic growth. The financial crisis resulted in house prices falling which had a negative wealth effect on homeowners as they didn’t feel as wealthy and lost their confidence despite their income not changing because their assets weren’t valuable to them. The low confidence incentivised homeowners to save rather than invest or spend, consumption is component of AD. Also, the falling price incentivised consumers to wait for prices to be lower before purchasing which decreased both consumer and producer’s confidence. As consumptions falls AD shifts to the left from AD1 to AD2 causing price levels to fall from PL1 to PL2 as well as national output to fall from Y1 to Y2. This indicates that there was less being produced and at a lower price which decreases the productivity of a firm and increase in spare capacity, there is reduction in economic growth of a country.
Another negative demand side shock that resulted reduction in aggregate supply was another financial crisis which was the eurozone crisis where certain European countries were able to pay their debts. Due to lack of fiscal policy in southern countries incentivised them to borrow and private debts in property bubble which means house prices were falling which had a negative wealth effect on homeowners and they weren’t as optimistic about the future so incentivised them to save and lower investments in the economy reducing the country’s GDP resulting in reduction economic growth. Investment is a component of AD, AD shifts to the left from AD1 to AD2 causing price levels to fall from PL1 to PL2 as well as national output to fall from Y1 to Y2. This indicates that there was lack of investors in the stock market and cause stock market crash making many feel less wealthy to spend.