Question

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

Answer - In the short run as a result of the decrease in the prices of oil , the level of investment and production will increase due to lower cost , hence the AS will increase. Also , the lower cost of oil will result in the increase in the real income of consumers. Hence the consumption of the other goods will also incease. As a result , the AD will increase.

All the above changes in the short run will lead to the increased demand and the rising prices in the long run.