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earlier this year, oil prices fell to historic lows. Using the aggregate demand and aggregate supply...

earlier this year, oil prices fell to historic lows. Using the aggregate demand and aggregate supply model from chapter 10, explain the effects of the drop in oil prices on the economy (a) in the short run and (b) in the long run.
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Answer #1

Oil acts as a major input in majority of manufacturing in the world in one form or another. When oil gets cheaper, the costs of production goes down. This in AD-AS model helps to shift aggregate supply(AS1 TO AS2) to the right. Average prices go down and assuming people still have enough aggregate demand(AD1 will go to AD2), people will consume more in the short run. If this keeps happening then Long run aggregate supply shifts right and economy attains higher potential.

Refer diagram below:

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