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During the 1970s the US experienced “stagflation” as a result of an increase in energy prices...

During the 1970s the US experienced “stagflation” as a result of an increase in energy prices when OPEC decided to limit oil production and raise prices. Show and explain what this did to the AS AD scenario/equilibrium. (Note: stagflation refers to a recession and inflation at the same time so that both inflation and unemployment are abnormally high at the same time. The economy is “stagnant” in terms of growth but inflation is also high)

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Answer #1

US economy experienced stagflation that caused fall in output and rise in price kevel.

Shift in the supply curve was caused by the massive rise in cost of production. Rise in oil price increased cost of production. Hence suppliers we're compelled to reduce supply. It increased unemployment rate significantly.

Following is the diagram:

AS2 AS, 7 AP BV

In above diagram, rise in cost of production shifts the supply curve to left thereby causing rise in price from P1 to P2 and output falls from Q1 to Q2.

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