Question

solve using attached graphs if neccesary

(2) 140 points Use the standard short-run AD-AS model to answer this question. (Assume that all the taxes in this model are income taxes.) Economists do not agree on the cause of the 1991-92 recession in the U.S. The two most promising explanations are: (A) the "oil price shock" explanation, and (B) the "credit crunch" explanation. The oil price shock explanation says that when Iraq invaded Kuwait in the summer of 1990, this created expectations that oil supplies would be reduced and therefore caused the price of oil to increase dramatically around the world. As a result, the U.S. was hit with a supply shock. The credit crunch explanation says that when the price of U.S. real estate collapsed in 1989 and 1990, many banks lost money on their real estate loans. Thus, for the next year or so, banks became much more cautious about making loans of any type. As a result, there was a reduction in investment. (a) Consider a hypothetical recession caused by an "oil price shock," that is, a large increase in the cost of crude oil. Use the AD-AS model and a copy of the attached AD-AS / IS-LM / Money market graph. Show only the short-run effects of an "oil price shock." Label the initial equilibrium points E and the new equilibrium points J. List the changes in P., Y.C.I.G, TA. TR, and GBD for the short-run. Briefly explain. (b) Consider a hypothetical recession caused by a "credit crunch" that is, a decrease in lending by banks which forces investment, I, down. Use the AD-AS model and a second copy of the attached AD-AS / IS-LM / Money market graphs. Show only the short-run effects of a "credit crunch." Label the initial equilibrium points K and the new equilibrium points M. List the changes in P., Y, C.I.G. TA, TR, and GBD for the short-run. Briefly explain. (c) Discuss the similarities and differences between these two types of hypothetical recessions. In particular, compare what happens to each of the nine macroeconomic variables P.I.Y.C.I.G. TA. TR, and GBD listed above. For which variables are the effects similar? For which are they different? Which of these variables would you most want data on in order to determine which explanation of the recession is most accurate? Briefly explain. O melha 9 N

Answer 1

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