Illustrate short-run effect of a temporary oil price shock

Reference no: EM132884096

Oil price shocks have been a reoccurring phenomenon over the last fifty years, causing significant fluctuations in the price of oil. Examples of oil price Page 4 of 4 shocks include the early 1970s caused by the OPEC oil embargo, the early 1990s caused by the Gulf War, and the Arab Spring during the early 2010s. Oil-importing nations like Australia are significantly affected by rising oil prices. Nonetheless, evidence has shown that oil price shocks are a temporary phenomenon and eventually, prices decline. Assume that there is no fiscal policy response from the government in relation to an oil price shock.

Question a. Explain and illustrate the short-run effect of a temporary oil price shock on macroeconomic equilibrium using the AD-AS model.

Question b. Explain and illustrate the adjustment process to back to long-run equilibrium based on the following:

i. Self-correcting mechanism (i.e., with no policy response).

ii. Active stabilisation response (i.e., with policy response). [Hint: there could be two active stabilisation polices here].

Reference no: EM132884096

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