Question

1. Describe the effects of each of the following events on the US economy (i.e. What may happen to the price? To the real output?). Explain briefly what cause these effects (i.e. What happens to determinants of AD or AS or both? Why? ).Illustrate your answers in given AD-AS diagrams. Label your diagrams and changes carefully. a) Potential middle-east war pushed the price of oil higher. b) Technology innovation results in a more efficient production method of goods. c) Stock market crash in the early 2000s wiped out a significant amount of wealth of American households.

Answer 1

a) increase in price of oil increases the cost of production which further decreases the supply. Thus aggregate supply, AS shifts to the left. At new equilibrium e' price increases and quantity decreases.

b) technological innovation increases productivity and increases the supply which leads to rightward shift in aggregate supply curve. At new equilibrium e' price decreases and quantity increases.

c) stock market crash reduces the consumer's wealth which makes them to spend less. This leads to decrease the consumption spending. Thus Aggregate demand shifts to the left. At new equilibrium e' both price and quantity are lower.