The Impact of Drought on the Macroeconomic Equilibrium in Australia

In this assignment we will discuss about economic and below are the summaries point:- Drought has direct impact on energy sector and agriculture, reducing supply and increasing cost of operation Reduction in supply and use of alternative power sources raises cost of operation and inflation Drought increases government expenditure and reduces overall output and aggregate demand.

ECONOMICS ASSIGNMENT

Contents
Introduction................................................................................................................................3
Impact of drought in the economic equilibrium.........................................................................3
Conclusion..................................................................................................................................6
Reference....................................................................................................................................7

Introduction
Economics at the macro level is vulnerable to the changes in many different factors. Drought
is one such factor that influences activities in different parts of the economy. Drought directly
impacts the aggregate demand in the economy that further changes the equilibrium. The
objective of this paper is to shed light on the impacts of drought in the macroeconomic
equilibrium and set of Australia. The data and information for the analysis of the paper have
been collected from different government databases and news article pertaining to the recent
drought in the country. Apart from that, other similar studies done on the previous occasions
of drought in Australia have also been referred to in order to present a discussion of the topic.
Impact of drought in the economic equilibrium
The most direct and profound impact of drought in the economy of Australia has been in the
energy sector of the economy. A water turbine is one of the major sources of power in the
economy of Australia which gets affected due to drought. Lack of water limits the operation
of the power plants and hence the supply of energy in the economy gets reduced. This, in
turn, contributes to the increasing cost of the operation of the organizations. Lobell, Hammer,
Chenu, Zheng, McLean & Chapman (2015) stated that power or energy is one of the most
common inputs in any kind of business in the economy. Therefore, reduction in the supply
and use of alternative source of power increases the cost of operation. This further influences
the price of goods and services in the economy and inflation increases.

Figure 1: The leftward shift in aggregate supply
(Source: Dai & Zhao, 2017)
Another major influence that can bring changes in the macroeconomic equilibrium of
Australia is the reducing production in the agriculture sector of the economy. Agriculture
contributes around 39% to the national GDP of Australia and most of the products are sold in
the global market. Deo, Kisi & Singh (2017) highlighted that 77% of the agriculture products
of the country is exported to different countries of the world. Drought reduces the
productivity of the soil and hence at each price point the farmers produce less amount of
products. The supply curve shifts to the left increasing the price level in the economy.
Therefore, inflation is a common outcome of drought that gets boosted from different
dimensions of the economy. The new equilibrium in the economy due to drought also reduces
the overall output of the economy as shown in the figure 1. Again, the output of the economy
is also reduced due to the lowered aggregate demand for goods and service as well. Inflation
reduces the disposable income of the consumers of the market and hence consumers
consumer fewer amount of goods and services.

Apart from that, drought also increases the expenditure of the government. Low, Grant,
Hamilton, Gan, Saphores, Arora & Feldman (2015) noted that the government spending of
Australia increases by around 33% in the year of droughts. It is the responsibility of the
government to restore the productive units of the economy during and after the drought. The
government also provides subsidized electricity to many important industries of the economy
as well. This creates a burden to the government leading to an increase in inflation in the
economy. In addition to that this increase in expenditure from the side of the government to
support the economy deprives the other sectors of the economy and hence the quality of
public provisions deteriorates.
Reducing overall output as discussed above further influence the trade pattern of the
economy as well. The economy of Australia during the times of droughts increases its import
from foreign economies as prices in the domestic market skyrockets. Thus, the trade deficit
increases and hence the demand for the currency of Australia reduces. Edwards, Gray &
Hunter (2015) stated that the economy also becomes vulnerable to changes in the global
economy as well. Therefore, drought damages the activities of domestic organizations.
Further, reducing the value of the Australian dollar and the increasing import contributes to
higher foreign spending. In case of further devaluation of the Australian dollar, consumers of
Australia spend more for the same good leading to a loss of welfare.
Further, the instability in the economy hampers the equilibrium pertaining to the investment
inflow in the economy as well. Investment inflow is one of the major fuels for the
development of infrastructure and economic growth. Among the many factors that determine
the amount of inflow, the stability of the economy is the most important. The instability in the
economy of Australia owing to drought-reduced consumer spending can reduce the rate of
interest for the investors (Capon & Reid, 2016). Figure 2 below depicts how investment and
interest rate are negatively related to each other.

Figure 2: Interest rate and investment inflow
(Source: Capon & Reid, 2016)
The government can take many actions to correct the negative impacts of the drought. One of
the common government actions that can be seen during the times of drought is a reduction in
interest rates. This discourages the consumers to put their money in the bank and increases
the demand for loan. This increases the demand for goods and services and brings back the
economy to its position (Brown, Versace, Lester & Walter, 2015). In addition to that, the
government also reduces the prices of other energy sources in order to maintain a stable
demand for energy in the market. This ensures a comparatively lower operational cost of the
organizations. This further reflects in the reduced price level in the economy and hence the
inflation becomes under control of the government (O'loingsigh, McTainsh, Parsons, Strong,
Shinkfield & Tapper, 2015). Open market operations can also be seen from the side of the

central bank of the country during the times of drought that further bring downs the inflation
level.
Figure 3: The reduction in money supply and increase in interest rate
(Source: O'loingsigh et al. 2015)
Conclusion
Therefore, the paper has presented a discussion pertaining to the impacts of drought in the
macroeconomic equilibrium of the economy of Australia. It has found out that, the increase
in the inflation rate is the major influence of drought which can be managed through proper
policies of the government. The Australian government undertakes a few of the measures
such as reducing the interest rate in order to have more control over the inflation of the
market. Apart from that another major impact of the drought is on the aggregate demand that
changes the equilibrium which reflects higher prices and lower output in the economy. The
government of Australia tackles the lower aggregate demand by investing in other sources of
energy so that they can meet the needs of the business and hence the operational cost can be

lowered. This lower operational cost reduces the price level and increases the aggregate
demand for goods and services in the economy of Australia.

Reference
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