Question

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

Answer 1

A) drop in the oil prices will decrease the cost of production for most of the goods and services. This increases production and helps in increasing aggregate supply. In the short run aggregate supply curve shifts to the right. Price level declines and real GDP increases

B) during the transition from short run to long run, as the oil prices adjust, the production cost increases and this decreases the production. Aggregate supply curve shifts to the left. Price level is increased in real GDP is reduced. The economy is now reached back to its initial full employment equilibrium.