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Real GDP

Suppose the recent volcanic events in Iceland, which disrupted European air travel significantly, represented just the beginning. In other words, suppose that experts predict a world-wide series of huge eruptions from active volcanoes. The Yellowstone caldera is anticipated to be the largest--the caldera is roughly 30 miles by 40 miles.

Use the AD/AS model to describe what will happen in the short run and long run to the world real GDP and the price level. Moreover, describe what policymakers could do after this has happened.

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Vast quantities of volcanic ash in the atmosphere would devastate the market for most goods and services. Food production would be the first affected, since most crops require abundant sunlight. This would shift the supply curve backwards. Price levels would increase as the market would allocate food to those best able to pay for it.

The movement of the demand curve would depend on the time frame. Initially demand for food, water, and other supplies would skyrocket, as people would panic in anticipation of a famine. However the demand for luxury goods such as new cars and designer clothes would plummet. In fact the demand for most goods and services would fall as ...

Solution Summary

Aggregate supply and demand after a natural disaster