Question

Assignment:

Two significant events have occurred. One, the OPEC members and Russia got together and increased the production of petroleum. Their goal was to lower the worldwide price of petroleum (crude oil) and drive higher-cost producers from the market, principally the fracking producers in the United States. (This is a good example of an imperfect market where one or more of the participants can manipulate the price.) At the same time, the COVID-19 pandemic spread across the world, reducing demand for petroleum products (manufacturing, energy, and transportation).

Draw a supply and demand diagram for the worldwide petroleum market. Shift supply to the right. Then shift demand to the left. Note the huge drop in price.

The American gasoline market mirrors the worldwide petroleum market. Lowering the cost of the input – petroleum – shifts supply to the right. Reduced driving shifts demand to the left. Show this on a supply and demand diagram. Note the drop in the price of gasoline.

The macro model for the US.

The COVID-19 pandemic led to the shutdown of many aspects of production in the country as firms closed down. As a result, on a macro model, Short-run aggregate supply (SRAS) shifted left. Also, the buying public swiftly decreased purchases. As a result, AD shifted to the left. The government has passed a large stimulus bill designed to shift AD back to the right. It will take time to fully implement. The Federal Reserve has injected huge amounts of liquidity into the system with the same goal in mind.

Draw a macro model. Identify the starting equilibrium point. Then shift SRAS to the left. Follow by shifting AD to the left. At the new equilibrium point, note that real GDP decreased sharply. Depending on how you drew the shifts, inflation (price index) probably did not change much. Now begin shifting AD to the right in small steps, indicating that the stimulus plan and the Fed’s injections begin to take effect. See the possibility of emerging inflation as this occurs, with AD shifting right and AS stationary.

As the country ends lockdown and begins to reopen, AS will slowly begin to shift to the right. Do not be surprised if the Fed begins to withdraw some of the liquidity to slow down the rightward movement of AD.

Answer 1

1. FIG A below graphically describes the impact of two important events on the demand and supply for worldwide petroleum market.

First, increased production of petroleum due to the coming together of OPEM members and Russia reflected by rightward shift of supply curve from SO1 to SO2

Second, reduced demand of petroleum products due to spread of COVID-19 pandemic reflected in leftward shift of demand curve from DO1 to DO2

As a result, there is a huge fall in market price of petroleum (from P1 to P2) and fall equilibrium quantity (from Q1 to Q2)

2. FIG B below similarly graphically describes the impact of above-mentioned events on the demand and supply for US gasoline market. The reduced cost of the input-petroleum shifts supply curve to the rightward from SO3 to SO4. On the other hand, reduced demand due to lockdowns for preventing spread of COVID-19 disease leads to leftward shift in demand from DO3 to DO4. Together, these 2 factors lead to fall in gasoline market prices (from P3 to P4) and quantity bought & sold in the market (from Q3 to Q4).

3. FIG C below graphically describes the impact of COVID-19 pandemic responses on the US short-run macro economy. Initially, due to lockdown and closures of households and firms for preventing the spread of COVID-19 disease led to leftward shift in Short-run aggregate supply (SRAS) from SRAS3 to SRAS4; and leftward shift in Aggregate demand (AD) from AD3 to AD4. This leads to fall in aggregate output from Y3 to Y4 although there is no change in the price index (PL3/PL4).

Next, as a part of economy support and recovery package, government passed large fiscal stimulus package and Federal reserve also provided the monetary stimulus to boost AD from AD4 to AD5. As a result, the aggregate output increased from Y4 to Y5 although price-index also increased from PL4 to PL5.

Finally, as the lockdown is eased and ended, the economy will open and SRAS4 shifts rightward to SRAS5 and AD5 shifts rightward to AD6 leading to increase in aggregate output from Y5 to Y6 and reduction in price level from PL5 to PL6.