Question

We will make predictions about changing equilibrium in an economy facing various shocks. For each of the following questions, start with an initial supply-demand graph and make changes as needed.

a) Draw aggregate supply and demand curves for the economy. Suppose an economy is hit by an energy price spike. Show how the increase in production costs might affect the supply-demand equilibrium. What are your predictions for price and quantity?

b) Now suppose the Fed decides that the economy needs a boost, so it lowers interest rates (starting from the original equilibrium). What does this do to the supply-demand equilibrium? What are your predictions for price and quantity?

c) What can we say about the change in the equilibrium price and quantity if both of these events happen (ie. the economy is hit by an energy shock and the Fed responds with expansionary policy)?

Answer 1

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