Question 2: COVID-19 in the macroeconomy (14 marks)

Starting with the long-run equilibrium in the aggregate demand and supply (AD-AS) model. Consider the macroeconomic effects of the lockdown measures due to COVID-19. In each part of your answer, please be brief and concise in less than a hundred words. You need to make assumption clear, reasonable and explicit if making any. The quality and logic of arguments determine your marks.

a)Explain this development in the AD-AS framework in words (Diagrammatic representation not required) (2 marks).

b)Show Part a) using AD-AS figure. Ensure to include short-run supply curve (SRAS), long-run supply curve (LRAS) and aggregate demand (AD) and to label the X-axis and Y-axis of the figure. Also, mark the equilibrium price and quantity before and after the lockdown. (2 marks)

c)Fiscal and monetary policy measures can be taken as the response to the development in part a). Explain the policy measures in writing. Diagrammatic representation of the effects of these policies not required. (3 marks)

d)What are the possible long run impacts of the recommended policy measures in part (c). Explain the impact in writing. Diagrammatic representation not required.

e)Continue on the long-run, the government starts to register the budget surplus after having paid off the large budget deficits incurred as the policy measured in part c). What happens to the quantities of saving and investment and (real) interest rates with this development? Explain in writing. Diagrammatic representation not required (Hint: try to explain the step by step).