COVID-19 and the Canadian Economy: An AS/AD Perspective

Introduction

The COVID-19 pandemic caused significant disruptions to the Canadian economy, affecting both aggregate supply (AS) and aggregate demand (AD). This study guide analyzes the macroeconomic impacts of the pandemic using the AS/AD framework, focusing on key outcomes such as inflation, unemployment, and real GDP per capita. The analysis is divided into two phases: the Lockdown period (2020) and the Reopening period (2021–2022).

Macroeconomic Factors

Supply-Side Factors

Supply-side factors influence the economy's productive capacity and the costs of production. During the pandemic, several key supply-side shocks affected the Canadian economy:

• Government Lockdown/Regulation: Mandatory closures and capacity limits reduced the ability of firms to produce goods and services, shifting the aggregate supply curve leftward. Over time, businesses adapted through remote work and new service models, lessening the impact of ongoing restrictions.

• Oil Prices: Oil is a critical input for many industries. During the Lockdown, oil prices fell sharply due to reduced global demand. In the Reopening period, oil prices rose as demand returned and were further pushed up by geopolitical events (e.g., Russia's invasion of Ukraine), increasing production costs and further constraining aggregate supply.

• Supply Chain Issues: Disruptions in global supply chains, including factory shutdowns and transportation bottlenecks, limited the availability of intermediate goods. These issues began during the Lockdown and persisted into the Reopening period, as supply could not keep pace with rebounding demand.

Example: The Global Supply Chain Pressure Index (GSCPI) rose significantly during the pandemic, indicating widespread supply disruptions.

Demand-Side Factors

Demand-side factors primarily affect household consumption, the largest component of aggregate demand. The pandemic influenced demand through several channels:

• Government Lockdown/Regulation: Restrictions on travel, dining, and in-person services reduced households' ability to spend, causing a leftward shift in aggregate demand during the Lockdown period. As restrictions eased, demand recovered.

• Government Stimulus: Income supports and wage subsidies helped stabilize household finances, preventing a collapse in consumption. These measures supported aggregate demand during the Lockdown and contributed to a strong rebound during the Reopening.

• Pent-Up Demand: As restrictions lifted, households released postponed spending, especially on services. Elevated savings from earlier in the pandemic fueled a surge in consumption, pushing demand above pre-pandemic levels.

Example: Real household consumption spending per capita dropped during the Lockdown but rebounded sharply during the Reopening period.

Macroeconomic Outcomes

The interaction of supply and demand factors during the pandemic led to significant changes in key macroeconomic indicators:

Real GDP per Capita

• Definition: Real GDP per capita measures the average economic output per person, adjusted for inflation.

• Trend: Decreased during the Lockdown due to reduced production and demand; increased to above pre-pandemic levels during the Reopening as the economy recovered.

• Formula:

• Example: Canadian real GDP per capita fell in 2020 but surpassed 2019 levels by 2022.

Inflation

• Definition: Inflation is the rate at which the general price level of goods and services rises, eroding purchasing power.

• Trend: Inflation decreased during the Lockdown (due to reduced demand and lower input costs) but rose above pre-pandemic levels during the Reopening (due to supply constraints and surging demand).

• Formula:

• Example: The annual percentage change in the Consumer Price Index (CPI) was negative or low in 2020, then increased sharply in 2021–2022.

Unemployment

• Definition: The unemployment rate is the percentage of the labor force that is jobless and actively seeking work.

• Trend: Unemployment spiked during the Lockdown as businesses closed, then fell below pre-pandemic levels during the Reopening as the economy recovered and demand for labor surged.

• Formula:

• Example: Canada's unemployment rate rose sharply in 2020 but declined to historic lows by 2022.

Summary Table: Pandemic Phases and Macroeconomic Outcomes

AS/AD Framework Application

• Aggregate Supply (AS): Represents the total quantity of goods and services that producers in an economy are willing and able to supply at different price levels.

• Aggregate Demand (AD): Represents the total quantity of goods and services demanded across all sectors at different price levels.

• Shifts in AS and AD: The pandemic caused both AS and AD to shift left during the Lockdown, reducing output and price levels. During the Reopening, AD shifted right (due to pent-up demand and stimulus), while AS remained constrained, leading to higher output, higher prices (inflation), and lower unemployment.

Example: The simultaneous rightward shift in AD and constrained AS during the Reopening period explains the combination of rising GDP, high inflation, and falling unemployment.

Key Takeaways

• Both supply and demand shocks played major roles in shaping the Canadian economy during COVID-19.

• The AS/AD model provides a useful framework for understanding the interplay between policy, external shocks, and macroeconomic outcomes.

• Government policy (lockdowns, stimulus) and external factors (oil prices, supply chains) had dynamic and evolving effects over the course of the pandemic.

Additional info: The document notes that monetary policy (interest rate changes by the Bank of Canada) also influenced aggregate demand, but this is covered in later chapters.