Question

An oil cartel effectively increases the price of oil by 100 percent, leading to an adverse supply shock in both Country A and Country B. Both countries were in long-run equilibrium at the same level of output and prices at the time of the shock. The central bank of Country A takes no stabilizing policy actions. After the short-run impacts of the adverse supply shock become apparent, the central bank of Country B increases the money supply to return the economy to full employment. Describe and compare both the short-run and long-run impact of the adverse supply shock on prices, output and unemployment in each country.

You may need to draw diagrams to determine the impact. However, do not provide diagrams with the answer. (125 words maximum)

Answer 1

Country A:

The rise in the oil price causes the stagflation in the economy and short run supply curve will shift to the left.

following is the diagram:

The SRAS supply shifts to the SRAS1. this here price rises, and output level will decline.

If government does not intervene, over the short run unemployment would be there but over the long run, the flexible price and wage would reduce the price and supply curve will again shift to right and economy will come to full employments.

Country B.

The intervention of government or monetary authority would increase the aggregate demand to right AD1 as the central bank follows the expansionary monetary policy.

Following is the diagram:

The aggregate demand shift to right AD1 and economy come to full employments even in the short run.

Further, the expansionary monetary policy would shift the demand and price would be high permanently,