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ECOASS5 Economics For Business Of Equilibrium

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  • Course Code: ECOASS5
  • University: Victoria University
  • Country: Australia

Question:

Using appropriate diagrams, explain the likely impact of drought on macroeconomic equilibrium in Australia. Use evidence drawn from media reports to illustrate you answer. How might government policy response to the drought modify the macroeconomic impact of the drought?
 
 

Answer:

Introduction

In this essay, the prospective effect of drought on macroeconomic equilibrium of Australia has been discussed. Drought indicates a dry climatic condition resulted from insufficient rainfall in a specific region. Drought affects an economy by influencing mainly supply side variables. Farms, business and common people are likely to suffer due to drought. Based on intensity the effect of drought might be local, regional or economy wide. Agricultural production is most vulnerable to drought. In addition to farm sector, thermal and hydro-power generation and other associated sectors get suffered following drought. The essay also sheds light on possible impact of government intervention during drought.

The analysis of macroeconomic equilibrium involves evaluation of two important concepts of aggregate demand and aggregate supply. These are the two determinants forces of equilibrium in an economy. Aggregate demand is the total demand of goods and services in an economy. It includes demand from household, business, government and net export. Aggregate supply represent the total amount of goods and services available at varying price level. Aggregate supply curve in the short run though is positively sloped; in the long run it is vertical corresponding to potential GDP. Aggregate demand curve in contrast a negatively slope curve representing inverse association between price and aggregate demand. Short run equilibrium is obtained corresponding to short run aggregate demand and aggregate supply (Heijdra, 2017). Stable macroeconomic equilibrium in the long run occurs where short run and long run aggregate supply and aggregate demand curve balance. In the above figure, macroeconomic equilibrium is shown by point E.

Evaluation of impact of drought

The stable macroeconomic equilibrium is vulnerable to change in demand or supply condition in the economy. Change in equilibrium condition causes a change in GDP, price level, employment and other associated variables. An unfavorable weather condition adversely affect productivity and hence, is considered as a negative supply shocks. Aggregate supply reduces due to contraction in total product in several sectors. Firstly, the dry weather condition resulted from deficiency in rainfall disrupts crop production. As agriculture constitutes a part of total output, significant decline in farm production causes a decline in aggregate output. Secondly, lack of water in thermal and hydroelectricity production hampers energy supply and raises price. Due to increased cost of energy most businesses in the economy faces a decline in output. Decrease in aggregate supply shifts aggregate supply curve to inward (Heijdra, 2017). Consequently, there is a decline in GDP. Condition of supply shortage creates pressure on price level resulting in an inflation.

The impact of drought on macroeconomic equilibrium of Australia is explained in the above figure. A decline in aggregate supply shifts aggregate supply curve inward from SRAS1 to SRAS2. As a result, economic equilibrium moves from E to E1.  As shown in the above figure, the real GDP then declines to Y2 while price level increases to P2.

Since the introduction of systematic weather recording in the late 19th century, there were three severe droughts in the Australian economy. These are Federation Drought longed from 1895 to 1903, drought during world war II and Millennium Drought lasts from 2001 to 2009. In the meantime, there are several minor droughts. Recently, dry condition has been experienced in eastern Australia over the winter months having an abnormally high temperature. The obvious impact of drought in Australia was felt in terms of a huge decline in agricultural production. The adverse effect of drought was also felt on live stocks. During drought, there was a recorded decline in meat production. In the last fifty-year span, real gross farm product in Australia fell by 27.5 percent. There is a relatively small decline in farm output during recent drought as they were more concentrated in regions. Drought has also affected the broader economy of Australia. Agricultural output constitutes 12.5 percent of nation’s GDP. Drought occurred in the middle of 1960 reduced real GDP growth by 2.5 percent on an average. The drought of early 1980s, decline in agricultural output reduced real GDP growth by less than 6 percent. Drought also affected the balance of payment account by reducing rural export. Agriculture now accounts 10 percent of total export in Australia. Decline in farm’s output caused a contraction in employment.

 

Government policy intervention

Government intervenes in an economy to correct economic shocks. Demand sided policy can be taken to boost aggregate demand. An obvious way of government’s help is to give financial and other assistance to the farmers and affected rural communities in times of severe drought. The Federal Labor Government launched National Drought Policy in 1992 (abc.net.au., 2018) Government through this policy introduced subsidized interest rate and program for farmers’ family support.

 The continuous assistance of government helps to reduce severity of drought. The increasing probability of drought precautionary events during summer and spring implies that drought conditions are likely to continue in eastern Australia meaning that impact of drought in the economy now is relatively smaller compared to that in 2000s.

The fiscal policy expansion by government helps to alter economic outcome. The policy works through stimulating aggregate demand. Expansion of government spending increases aggregate demand. Increase in aggregate demand causes aggregate demand curve to shift to the outward direction. The corrective measures by expanding aggregate demand increases both real GDP and price level. As output recovers, there is expansion of economic activity and employment.

Conclusion

The essay evaluates likely effect of drought on economic equilibrium of Australian economy. The economy realizes an adverse supply shock following drought. There is a considerable decline in output in different sectors of the economy. Agriculture, energy and other associated sectors are adversely affected by drought. There is a contraction of aggregate output. The economy feels an inflationary pressure due to drought. Australian economy has already experienced a series of major and minor drought. Government intervenes to correct economic outcome during drought. Successful policy implementation helps to reduces severity of drought impact and restores stable equilibrium.

 

List of References

abc.net.au. (2018). 'Privatising profits, socialising losses': is this a fair slur against farmers?. Retrieved from https://www.abc.net.au/news/2018-10-02/drought-policy-is-always-fraught-but-farmers-say-its-broken/10326012

Heijdra, B. J. (2017). Foundations of modern macroeconomics. Oxford university press.

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