Question

Use the following data to work Problems 1 to 4:

The following events have occurred in the history of the United States:

• A deep recession hits the world economy.
• The world oil price rises sharply.
• U.S. businesses expect future profits to fall

Explain the combined effects of these events on U.S. real GDP and the price level, starting from a position of long-run equilibrium

Answer 1

• a) A deep recession in the economy-Recession  is a situation when there is decrease in income , output and employment . There is noinvestment . Therefore aggregate supply decrease and shift backwards. At the same time due to recession , people lost their belief in government and consume less goods and services . Due to that aggregate demand falls . Due to fall in aggregate demand and supply equilibrium price remain the same but real GDP falls from q to q1 .

  

  B) Increase in world oil prices. Due to increase in oil prices , consumption of oil will decrease and aggregate demand for oil will reduce . Therefore, aggregate demand curve will shift backwards. Due to that, equilibrium price will fall and real GDP will also reduce from o to o1. It has negative imppact on the economic growth of US.

  

  C) US business expect future profit to fall- When the producers of US feel that they will have less lose in future they reduce the production level and due to that aggregate supply falls. With reduction in aggregate supply , price level will increase in US from p to p1 and real GDP will fall from o to o1.