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Since Fall of 2011, the price of oil has shown a sharp increase again as continuation steady rise in oil price attributed to the Arab Spring (the political uprising in the Middle Eastern and North African countries) started in the beginning of 2011. This upward trend of oil price has been further triggered by the recent tension in Iran on its Nuclear proliferation and the threat of blocking the oil export through the Harmuz Strait. Accordingly, many analysts in the energy field have predicted the likelihood of rise in oil price up to $5/gallon by coming summer in the US market.
Given the circumstances above about the oil market, draw an AS/AD diagram, which shows the effect on the US macro-economy of expected oil price @ $130+ per barrel versus the oil price at $100+ per barrel (in the beginning of 2012). In your explanation in words about the diagram, you must clearly explain the connection between changes in oil price and the fluctuations in macroeconomic fundamentals in the US economy. Then show the impact of continuous rise oil price on the US economy by using the AD-AS model during the recovery period of the economy from its great recession of 2008.
Label your diagram clearly and explain how higher oil prices impact either AS, AD or both.
Finally, explain why sharp rise in oil prices might not necessarily have negative or positive impact on the US equity markets even at the current trend of volatile oil prices.4 pts.Note: Keep in mind that the oil price is not the same as the price level in macroeconomics diagrams, even though the changes in oil price indirectly affect the general price level (such as CPI and GDPD). You do not necessarily need to draw the diagram for oil market to answer this question. However, drawing of macroeconomic model of AD-AS behavior impacted by the changes in oil price is required.
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