6. Economic fluctuations II The following graph shows the short-run aggregate supply curve (AS), the aggregate demand curve (AD), and the long-run aggregate supply curve (LRAS) for a hypothetical economy. Initially, the expected price level is equal to the actual price level, and the economy is in long-run equilibrium at its LRAS of $80 billion. Suppose war in the world’s main oil-producing region sharply reduces the world oil supply, causing oil prices to rise and increasing the costs of producing goods and services in this economy. Adjust the appropriate curve or curves on the graph to reflect the increase in production costs in the short run.. Note: For simplicity, assume no impact of higher oil prices on LRAS. 140 LRAS 130 AS AD 120 110 AS hp W. 85°F Mostly cloud EVEL
Answer to question 1
An oil price increase will increase cost of inputs and firms will lower production, shifting SRAS0 leftward to SRAS1, intersecting AD0 at point B with higher price P1 and lower real GDP Y1.
Answer to question 2
An increase in taxes would reduce the disposable income i.e. Y – T and lower the consumption expenditure, this would lower the aggregate demand and shift the aggregate demand curve towards the left as shown below.
Answer to question 3
AD/AS model: The AD-AS framework demonstrates national income generation and price level fluctuations. We use this to show the stages of the economic cycle and how various scenarios may cause changes in two of our major macroeconomic factors like real GDP and inflation.