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Demand Shock

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Submitted By maca7296
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An economic shock is an unexpected and unplanned event that has affects on an economy. These shocks can affect both supply and demand causing both positive and negative effects on an economy. The nature of the impact on the economy as well as five macroeconomic objects of these shocks will depend on the strength of an economy at the time, which will determine how well they can react and coup with these shocks.

A demand side shock is an event that suddenly increases or decreases the demand for goods and services. In the event of major sports completion such as London 2012 could be referred to as mainly a shock to demand due to its effects on AD and its ability to boost growth in the economy.

The London Olympics 2012 forced the government to use fiscal stimulus (government spending) in order to build infrastructure witch would be needed for the games e.g. stadiums and the Olympic village. The Olympics also encouraged firms to invest due to the fact that they would be able to advertise heavily as well as gain high returns due to the tourism generate by the games. AD= C+I+G+(X-M). Both in vestment and government spending rose and there for had a positive effect on Aggregate Demand.

The employment of workers to build and running these complexes helped reduce unemployment in the short term as well as increasing household income, resulting in an increase in consumption causing a rise in AD. This shift in AD is shown by the shift from AD1 –AD2. Another major contributing factor to this sudden rise in AD is the increased tourism generated this invisible export will not only help boost ad and there for growth but also help improve the balance of payments.
However all the raw materials needed in order to construct the infrastructure may be imported due to the fact that they are cheaper this would worsen the balance of payments. Although governments may look to contract within the uk causing further stimulus to firms which with the increased output should employ more workers which would lead to more money and more consumption. This multiplier effect of wealth will be felt through the economy. These effects stated above are all the short-term benefits of London 2012.

Short-term benefit will include the fiscal investment spent on roads, housing an etc.… pushing out the UK’s productive capacity allowing for sustained growth. However the effectiveness of the games is not just tangible or in relation to GDP I’m referring to the legacy of the games, being a sporting competition the focus on health and being active is immense by government spending money on promoting this it should help the motivation for a healthier population which will increase the standard of living. Keynes’s animal sprits may come into play with all the excitement of supporting your country it could cause a feel good feeling which will encourage consumption through households as well as investment through firms. A sporting competitions can bring countries together strengthening trade links allowing for easier trade, which could help both the export market foreign investment which will have positive effect on the balance of payments.

This sudden burst in growth may cause demand-pull inflation where AD is rising to quickly for AS causing prices to rise. This is demonstrated in the graph above p1-p2 showing a rise in prices. However the extent to which inflation will effect the UK economy will depend on where we are on our AS curve. Seeing as the UK was still recovering from the 2007-08 credit crunch it is likely not to have much of an effect on prices as there is spare capacity within the economy.

The impact of this demand shock will depend on the strength of an economy. In the case of the UK the benefits listed above would have been real as our economy was in already in the stages of a recovery allowing the demand shock to give growth a major boost and for this boost not fizzle. The effects of a demand shock on a strong economy should still be felt years after the actually event due to the legacy it has. In comparison Brazil may not reap the same rewards from the upcoming games as motivation within the economy is low and the strength of the economy is low. It will defiantly have a very short-term growth effect but this will not be sustained into the long run.

In summary the effectiveness of the shock negative or positive will depend on the strength of an economy.

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