HW7 Bus 502

In 1974 and again in 1980 OPEC sharply increased oil prices (on each occasion the price of a barrel of oil increase by three to four times).

a. Using AS/AD graphs show the effect of rising oil prices on the US economy. (Unemployment and price level/inflation).

Rising oil prices have two effects on the common man 1) The oil consumption domestically will reduce 2) Companies manufacturing cost will increase and hence the production will decrease and the supply will decrease. Since the demand for basic commodities do not change, the aggregate demand will not change.

This will lead to increase in supply prices and hence reduction in investment by companies. This will lead to reduction in aggregate supply.

Real GDP will be higher than the potential GDP. It will have an inflationary effect on the economy and consumers will pay higher price for the goods.
Due to increased cost for the firms, the unemployment rate will increase as the firms might opt to reduce cost by firing employees.

b. What do you think would be the correct macroeconomic policy response?
Government can reduce the corporate tax. This will encourage private spending to continue and keep the unemployment in check. While since the government spending will reduce due to reduced revenue from corporate tax, the real GDP will reduce to potential GDP and the unemployment rate will be kept at check.

c. How would the economy return to equilibrium in the absence of any change in macroeconomic policy?
The economy will return to equilibrium as the consumption of the population will reduce. That way the aggregate demand will decrease to restore the