GDP Responses to Demand and Supply Shocks: A Comparative Study for Pakistan and U.S. Economies

Abstract

This study provides a comparative analysis of demand and supply shocks on gross domestic product for Pakistan and U.S. economies. Theoretical wisdom of macroeconomics states that demand shocks are temporary in nature whereas supply shocks have permanent influence on gross domestic product in the long-run. Main thrust of this study is to evaluate whether these propositions are immune to developmental stages. Once this immunity is established then this could lead to acceptance of generality of these theoretical propositions about these shocks in context of countries being considered. Pakistan being a developing economy provides a good fit for comparison to developed economy of U.S.A for their vast differences in resources, market structures and production technologies. A structural decomposition of gross domestic product is done for both of these economies. Long-run restrictions are employed for decomposition of gross domestic product for these economies in structural vector autoregressive model using time series data from 1973 to 2013 for both of these economies. Results indicate that demand shock appears to be more transitory and it explains less variation in gross domestic product as compared to supply shock for economy of Pakistan. Both demand and supply shocks seem to be critical sources of variation in U.S. gross domestic product.