Effect of Drought on Macroeconomic Equilibrium of Australia

Running head: ECONOMICS FOR BUSINESS
Economics for Business
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1ECONOMICS FOR BUSINESS
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.
Analysis
Macroeconomic equilibrium
Figure 1: Long run macroeconomic equilibrium

2ECONOMICS FOR BUSINESS
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