Question

The graphs illustrate an initial equilibrium for the economy. Suppose that oil prices temporarily decrease Use the graphs to show the new positions of aggregate demand (AD), short-run aggregate supply (SRAS), and long-run aggregate supply (LRAS) in both the short run and the long run, as well as the short-run and long-run equilibriums resulting from this change. Then, indicate what happens to the price level and GDP in the short run and in the long run. Short-run graph Long-run graph LRAS LRAS SRAS SRAS Short-run equilibrium Long-run cquitibrium AD AD Real GDP Real GDP Aggregate price level

Answer 1

Represent the graph showing the short run effect as follows: LRAS SRAS Aggregate price level AD Real GDP In the short run, a decrease in oil prices increases SRAS so price level decrease and GDP increase. New equilibrium is at point E. In the short run, price and equilibrium quantity and price would be determined by the shift of SRAS and its intersection with the level of demand. Since the SRAS shifts to the right the real GDP increases and the level of aggregate price decreases. Thus, in the short run, the price level decreases and GDP increases. Represent the graph showing the long run effect as follows:

LRAS SRAS Aggregate price level Real GDP Similarly, the long run level of price is determined by the intersection of LRAS and AD curve. At the long run, the level of real GDP adjust to full capacity rate. Here, the price level and the real GDP both stays the same. Thus, in the long run, the price level stays the same and GDP stays the same.