Electricity load-shedding in Pakistan is one of the biggest domestic problems faced by the country. Along with the problems that the power shortage brings for the society as a whole and for the inhabitants of the society the power failures seriously curbs the economic potential of the economy. Considering most of the medium and large scale industries of Pakistan depend on machinery that is run by electricity they are heavily dependent on the electricity supply, with the electricity supply cut their production capacity decreases dramatically as well.
Since most of Pakistani manufacturing industries lack the self generation ability hence this power outage is even more harmful to their business.
So eventually what ends up happening is that along with creating general distress among the public this power shortage reduces the production capacity of the firms and hence reduces the aggregate supply. Aggregate supply can be defined as the total supply of goods and services that firms in a national economy plan on selling during a specific time period.
It is the total amount of goods and services that firms are willing to sell at a given price level in an economy. It is the total amount of goods and services that firms are willing to sell at a given price level in an economy.
In the long run, the aggregate-supply curve is assumed to be vertical In the short run, the aggregate-supply curve is assumed to be upward sloping SRAS (Short run aggregate demand) shows total planned output when prices in the economy can change but the prices and productivity of all factor inputs e.g. wage rates and the state of technology are assumed to be held constant. LRAS (Long run aggregate supply) shows total planned output when both prices and average wage rates can change – it is a measure of a country’s potential output and the concept is linked strongly to that of the production possibility frontier The SRAS and LRAS can be graphically represented as follows:
Now what happens is that firms will have to cut down their production process in order to effectively meet the costs incurred or it will come to a position of losses. The cutting down of the production process means decreasing the supply of the firm. As a firm produces lesser than it did before, fewer workers will be needed because the excess labor has been made redundant since fewer employees are now needed to produce lesser output. Moreover, the firm can no longer afford to employ as many workers as it did before. Hence this will eventually give rise to over the course of time as many workers have will have to be laid off in industries due to low activity.
This will invariably decrease the total consumption of the population because as the unemployment increases the purchasing power of the people also falls. They are now earning fewer wages and the income effect will lead to a drastic decrease in the consumption. Consumption is one of the major contributors in the aggregate demand function. We define aggregate demand as the total demand for all goods and services produced in the economy at a given time and price level. It is the amount of goods and services in the economy that will be produced at all possible price levels. The aggregate demand is usually described as a linear sum of four separable demand sources.
C = Consumption I = Investment G = Government Spending (X-M) = Net Exports – Net Imports
The graph for AD is as follows:
It is often cited that the aggregate demand curve is downward sloping because at lower price levels a greater quantity is demanded. While this is correct at the microeconomic, single good level, at the aggregate level this is incorrect. The aggregate demand curve is in fact downward sloping as a result of the Pigou’s wealth effect. Pigou effect is an economics term that refers to the stimulation of output and employment caused by increasing consumption due to a rise in real balances of wealth, particularly during deflation.
Keynes said that a drop in aggregate demand could lower employment and the price level (deflationary depression). Hence it can be said that any decrease in the consumption would bring about a fall in the aggregate demand. Consumer demand or consumption, that is also known as personal consumption expenditure, is the largest part of aggregate demand or effective demand at the macroeconomic level. The interaction of the aggregate demand and aggregate supply gives us the market equilibrium. Now as has been previously pointed out, frequent power cuts will mean a cutting down of the production process which invariably brings about a decrease in the aggregate supply. What happens is that as aggregate supply decreases with the aggregate demand being constant (as obviously people would still be demanding the same quantity of products) inflation will increase as shown below:
Now here we can see with AS moving to a new point as it decreases it is actually increasing the price level which results in inflation and as a result unemployment increases as well, because when there is inflation in the economy there is a rise in prices hence there is a fall in the demand of goods and services and the producers reduce their production level and as a result they end up decreasing the number of workers which means unemployment increases. Unemployment on the macroeconomic level is a sign that the economy is operating below its full production capacity, this is a sign of inefficiency. Here we can see that inflation is playing a key role in determining the employment level. Hence we’ll have a look at how load shedding gives rise to inflation. Inflation is conventionally defined as a general increase in the level of prices in goods and services. One of the effects of inflation is a decrease in the value of money. During the course of inflation income and prices do not increase at the same rate; the purchasing power of the nation as a whole drops.
One of the reasons of inflation is surplus amount of money which causes the prices to rise at an extremely high rate. Other than that, another reason for inflation is the rise in the costs of production which in turn increases the prices of the products. Moreover inflation occurs when aggregate supply exceeds aggregate demand hence increasing the price level. In the context of load shedding though, we see that it has been a triggering stimulus for initiating inflation. The CPI inflation averaged 23.5 percent in July-February 2008-09 in Pakistan as against 8.9 percent in the comparable period of last year. The deficiency of energy sources is causing stir on the demand side of the economic picture causing an increase in the demand for energy sources as it has a huge effect on all spheres of economy of a nation having a primary influence on industry level.
The insufficiency of the available energy sources is causing the people to demand more electricity to meet their needs on the individual as well as industry level which in turn when observed in the context of graphical representation shows a shift of the demand curve to the right causing a shift of the equilibrium position increasing the price level. (Demand-Pull Inflation) The increase in level of inflation has also been caused due to an increase in the cost of energy sources. The scarcity of the energy resources available to the industries is making them shift to other sources for the purpose of energy generation which in turn has caused their costs to sky rocket.
Now, due to the heavy burden that everyone has to face in this state of affairs is causing a shift of the AS curve in terms of graphical representation of the scenario. The increase in the costs of production for the industries in turn affects the aggregate supply causing it to decline. This shift of the AS curve to the left also then causes the equilibrium price level to rise, in turn stirring up inflation in the society (Cost- Push Inflation). The power tariffs imposed would further increase the industrial input cost which is already very high making the products more expensive in the domestic as well as the international market. As far as the international market is concerned, the competitive edge of a country would be lost as their goods are more expensive in comparison to the other countries. The two types of inflation can be graphically represented as follows:
Demand- Pull Inflation