Question

Suppose we are examining the Australian economy in the short-run. Within the context of the AD-AS Model (the AS curve is upward sloping), assume the Australian economy is in equilibrium at y*, p*. Suppose the international price of oil falls. Because oil is to make final goods, what happens to equilibrium in the Australian economy if the price of oil falls?

Answer 1

Equilibrium levels of price and quantity are that levels of price and quantity where the demand curve intersects with the supply curve.

Oil is one of the main raw materials used in the Australian economy to produce final goods. With the decrease in the price of oil, the total cost of production of the final goods using oil as a raw material will also come down.

Decrease in the total cost of production will lead to increase in the level of supply of final goods. With supply being more than demand, the equilibrium level of price will come down and the equilibrium level of quantity supplied will increase in the Australian economy.