Evaluating Drought Impact & Government Policy in Australia

This essay evaluates the impact of drought on the Australian economy, utilizing the aggregate demand and aggregate supply model to illustrate the macroeconomic effects. It highlights how drought, as a negative supply shock, contracts aggregate supply, leading to decreased GDP and increased price levels, as evidenced by the 2002-03 drought. The essay further examines government interventions, such as expansionary fiscal policies and resilience packages, designed to support affected sectors and stimulate aggregate demand to recover real GDP and manage price levels. The analysis concludes that while drought poses a significant threat to Australia's economic stability, government policies play a crucial role in mitigating its impact and fostering economic recovery.

Running head: ECONOMICS
Economics
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Introduction
Lack of rainfall is one of the biggest threat for the agricultural sector. The phenomenon of
below average rainfall for a considerably long period is called drought. This a natural disaster
having a negative effect on people, business and the society. The intensity of impact of drought
depends on severity of drought. Based on the severity of drought the effect might be either local
or economy wide (Kiem & Austin, 2013) Objective of this essay is to evaluate impact of drought
on Australian economy. Additionally, the paper also examines the likely impact on government
policy intervention on economic outcome during drought.
Analysis
Aggregate demand and aggregate supply model
The two forces determining macroeconomic equilibrium an economy are aggregate
demand and aggregate supply. Aggregate demand is the sum of demand of all the produced final
product and services in the economy. It is represented as a sum of expenditure on consumption,
investment, government spending and net export. Aggregate supply represents the availability of
total product and services in an economy (Heijdra, 2017). The economy attains a stable
equilibrium where the aggregate demand is same as aggregate supply. The macroeconomic
equilibrium determines real GDP and price level of the economy. The aggregate demand and
aggregate supply model of macroeconomic equilibrium is described in the following figure.

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Figure 1: Macroeconomic equilibrium
Figure 1 portraits macroeconomic equilibrium with the aid of aggregate demand and
aggregate supply. AD1 shows the aggregate demand curve and SRAS shows the short run
aggregate supply curve. LRAS is the long run aggregate supply curve (Mankiw, 2014) The
interaction of aggregate demand and aggregate supply attains equilibrium corresponding to the
point E. At the equilibrium point, price level is P* and GDP is Y*.
Drought and impact on Australian equilibrium
An economy is in equilibrium unless some external forces changes either aggregate
demand or aggregate supply. Sudden shocks causes demand or supply to change shifting the
economic equilibrium. Natural calamities like drought destroy economic resources and hamper
production. The sector most vulnerable to drought is the agricultural sector. A certain amount of
rainfall is required to complete a crop cycle. Lack of sufficient amount of water damages crops

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and reduces productivity. As agricultural output constitutes part of the aggregate output, there is
a significance contractionary impact on aggregate supply. Not only output of agricultural sector
but also output of other sectors get hampered due to drought. One such example is production of
energy. The dry condition hampers production of both hydroelectric and thermal energy. Lack of
energy again reduces productivity of sectors highly dependent on energy sector. Australian
economy thus likely to experience an overall negative supply shock due to drought. As aggregate
supply contracts, the supply curve goes inward causing national output to decline. Because of an
economy wide shortage, there is an upward pressure on price level.
Figure 2: Adjustment to macroeconomic equilibrium after drought
The negative supply shock causes an inward shift of the aggregate supply curve inward to
SRAS1 (Argy, 2013) Consequently, the equilibrium shifts upward along the aggregate demand

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curve to E1. Corresponding to the new equilibrium, GDP falls to Y1 and price level increases to
P1.
The Australian economy already faced such consequences of drought. In the year 2002,
Australia suffered a drought. The drought severely affected different states and territories of
Australia. The economy experienced a deficiency of rainfall for a prolonged period of 11
months. Due to drought, there is a significant decline in grain production in the affected areas.
Gross Domestic Product in the agricultural sector fell by 24.3 percent. The decline in domestic
production causes a significant decline in agricultural export resulting in a decline in rural
income (Qureshi, Hanjra & Ward, 2013). Along with this direct and indirect employment related
to agricultural sector contracted by a significant extent. The resulted decline in food production
following drought led to an increases in food price which has a significant influence on overall
consumer price index. The food prices during this time rose by approximately 4.5 percent.
Reserve Bank of Australia estimated that the ongoing drought in Australia, would hamper the
economic growth largely costing the economy approximately $12 billion (sbs.com.au., 2018)
The Governor of Reserve Bank expressed the concern for an extended drought in terms of
significant impact on economic growth and prices of food. The worst effect of drought has been
realized by farmer living in states like NSW, northern Victoria and southern Queensland.
Government intervention
In order to overcome economic contraction government intervention is necessary to
support the farmers and other affected sectors. The drought policies in Australia have been
evolved gradually (Bennett, 2019) The twentieth century came with a significant expansion of
irrigation and interior that is drought-proof. During 1970, government introduced a scheme of
financial assistance to farmers in times of drought by the policy known as “National Disaster

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Relief and Recovery Arrangement”. In order to extend help to the farmers, a new scheme named
“National Drought Policy” was introduced. The Farm Management Deposit scheme aims to offer
farmers loans at a subsidized rate. Increase in government spending to support the drought –
stricken economy in forms of resilience packages is a part of expansionary fiscal policy
(Kendall, 2013) Expansionary fiscal policy in the economy targets to expands economic activity
by stimulating aggregate demand. Government spending being an important component of
aggregate demand, an increase in government expenditure leads to an aggregate demand. The
expansion of demand in the economy helps to recover real GDP and price level. The potential
impact of government policy intervention is shown below.
Figure 3: Impact of government intervention on economic outcome
Conclusion

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Drought is a natural disaster affecting the overall economy and life of people. In context
of macroeconomic equilibrium, drought brings a negative supply shock to the economy. With a
decline in production in agriculture and other sectors of the economy the aggregate output
contracts. Shortage in aggregate supply, pushes up price level with major contribution coming
from an increase in food price. Australia had already experienced such economic contraction
during the drought of 2002-03. The ongoing drought is likely to cost nearly $12 billion to the
economy. Government intervention in forms of different drought resilience policies aim to help
farmer and recover economic output.

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Reference list
Argy, V. (2013). International macroeconomics: theory and policy. Routledge.
Bennett, E. (2019). Policy and politicians are failing our environment and our future. Retrieved
from https://www.smh.com.au/environment/conservation/policy-and-politicians-are-
failing-our-environment-and-our-future-20190111-p50qt8.html
Heijdra, B. J. (2017). Foundations of modern macroeconomics. Oxford university press.
Kendall, M. (2013). Drought and its role in shaping water policy in Australia. In Drought in Arid
and Semi-Arid Regions(pp. 451-467). Springer, Dordrecht.
Kiem, A. S., & Austin, E. K. (2013). Drought and the future of rural communities: opportunities
and challenges for climate change adaptation in regional Victoria, Australia. Global
Environmental Change, 23(5), 1307-1316.
Mankiw, N. G. (2014). Principles of macroeconomics. Cengage Learning.
Qureshi, M. E., Hanjra, M. A., & Ward, J. (2013). Impact of water scarcity in Australia on global
food security in an era of climate change. Food Policy, 38, 136-145.
sbs.com.au. (2018). Drought could cost economy up to $12b. Retrieved from
https://www.sbs.com.au/news/drought-could-cost-economy-up-to-12b