Suppose the economy of the hypothetical country “X” is currently in equilibrium at point A on the graph. There were two major shocks to the economy in 2020. First shock was related to oil prices; the other was related to consumer confidence about future business conditions. Oil Shock: The economy X faced a rise in the average price of oil along with the rise of world price of oil. E) Would an increase in oil prices cause a demand shock or a supply shock? Redraw the diagram to illustrate the effect of this shock by shifting the appropriate curve. What happens to the Aggregate output and price level after the shock? (3)
Suppose the economy of the hypothetical country “X” is currently in equilibrium at point A on the
graph. There were two major shocks to the economy in 2020.
First shock was related to oil prices; the other was related to consumer confidence about future
business conditions.
Oil Shock: The economy X faced a rise in the average
oil.
E) Would an increase in oil prices cause a demand shock or a supply shock? Redraw the diagram to
illustrate the effect of this shock by shifting the appropriate curve. What happens to the
F) If policymakers wish to prevent the equilibrium output from changing in response to the oil
price increase, should they use contractionary or expansionary fiscal policy? (Redraw the graph
from part E and show the change) (4)
G) Even if the economy moves back to original Aggregate output, will there be any drawback? (1)
Consumer Confidence Index: The Consumer Confidence Index regarding future investment
opportunities, released from a survey in Country X, shows a constant fall.
H) Would the fall in consumer confidence cause a supply shock or demand shock in the short run?
Redraw the diagram to show the short-run effect of this shock on the economy by shifting the
appropriate curve. (3)
I) Now use the diagram from part H to show the new long-run equilibrium of the economy. (For
now, assume there is no change in the long run output). Explain the long-run effects on output and
the price level, assuming policymakers take no action (Hint: No intervention from the policymakers
necessarily assumes that the prices and wages are flexible in the long run)
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