Answer to Question #5534 in Macroeconomics for douglas walker
2. Using AD/AS, describe the short-run and long-run effects of an increase in the price of oil.
- in short run: equilibrium price rises from P0 to P1, output also rises from Q0 to Q1 and becomes above potential level (Q0), causing inflationary gap;
- in long run: because of inflationary gap and above level of output goes down from Q1 (long-run level) to Q0, prices goes up from P1 to P2, so we have new equilibrium (P2; Q0).
2. increase in price of oil causes increase of production costs. So aggregate supply:
- in short run: decrease and output also decreases from Q0 to Q1, price increases from P0 to P1, but general output is under its potential level;
- in long run: output goes back to its potential level – increases from Q1 to Q0, price increases from P1 to P2, so we have general increase in prices because of increase in oil price.
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