Question

Question 2: Introduction to Economic Fluctuations-Supply Shocks (12 points) Throughout much of the 1990s, the United States experienced declining energy prices. Assume that the U.S. economy was in long-run/short-run equilibrium before these oil price declines began. (a) Illustrate the short-run effect of declining energy prices using the AS/AD graph. Be sure to label all your curves and axes. Label the initial equilibrium as Point A and the new short-run equilibrium as Point B. [6 Points) (b) If there are no other changes in economic policy, what effect would declining energy prices have had on output and the price level in the short-run? 12 Points] (c) Suppose that the Federal Reserve had a policy to keep output from changing, what policy could the Federal Reserve adopt to respond to declining energy prices? Illustrate this policy in your graph from Part (a). Label the new resulting equilibrium as Point C. What is the long-term impact of the Federal Reserve taking action to respond to declining oil prices ? [4 Points)

Answer 1

price CRAS LRAS, SRASI "SRAS, A P ADI ADR a) The declining energy to SRAS 2 will Output price lend will shift the aggree short-ren aggregate supply right word from SRAS, b) The declining energy price when will shift SRAS from SRAS, to SRAS. As a result the price level will fall from P to P₂ and Output will increase from. Y, to Y. c) The federal reserve opt for contractionary monetary policy, such as buy selling gout bonds This will shift the AD curve leftward from AD to AD₂. This will reduce output Ho from Y, to " ( As reduction in money, to increase in interest rate! Thus, investment falls ) In the long-run that the lower price level the decrease ina money supply. and AD curve will shift back to its original position. This in long-lun Curie will shift to right from LRAS, AO CRAS supply leads * real. Pg will nullify AS