Can someone please help me with this?
Since fall of 2004, rising oil prices have frequently ended stock market rallies and led to declines in all major stock indexes. Draw an AS/AD diagram which shows the effect on the US macroeconomy of oil at a high price such as $100 per barrel versus oil at a moderate price such as $50 per barrel. Label axes and AS/AD lines on your diagram clearly and explain how higher oil prices impact either AS, AD or both
Thanks.
Energy is an important input to the production of many goods. When the price of oil drops, what should happen to aggregate supply? That is, at any given price will producers be willing to sell more, less, the same??. Shift your supply curve accordingly.
Now then, dropping oil prices should have an income affect on demand. If the price of oil (and subsequently gasoline) drops, you will obviously buy more gas. But will you also have more money to buy anything else? If yes, what does that imply about aggregate demand? Shift your demand curve accordingly.
Take it from here.
Of course, I can help you with that! To draw an AS/AD (Aggregate Supply/Aggregate Demand) diagram and understand the impact of high oil prices on the US macroeconomy, let's follow these steps:
1. Understand the AS curve: The AS curve represents the relationship between the overall price level in the economy and the quantity of real output (GDP) produced. It slopes upward because an increase in price level stimulates businesses to produce more goods and services.
2. Understand the AD curve: The AD curve shows the relationship between the overall price level and the total quantity of goods and services demanded in the economy. It slopes downward because as prices rise, the purchasing power of individuals decreases, leading to a decrease in aggregate demand.
3. Draw the AD curve: On a graph, draw an downward sloping curve from left to right, labeling it as AD.
4. Draw the AS curve: Draw an upward sloping curve starting from the bottom left corner, representing the AS curve. Label it as AS.
5. Add the axes: Label the vertical axis as the price level and the horizontal axis as the real GDP.
6. Indicate the initial equilibrium: Identify the initial macroeconomic equilibrium point where AD and AS curves intersect. Label it as point A.
Now, let's discuss the impact of higher oil prices, such as $100 per barrel, compared to moderate oil prices, like $50 per barrel:
- Higher Oil Prices ($100 per barrel): When oil prices increase, businesses' costs of production rise. This increase in costs affects the AS curve. Shift the AS curve to the left, showing a decrease in aggregate supply (AS2). This shift is due to increased expenses for factors of production and the reduced profitability of businesses.
- Moderate Oil Prices ($50 per barrel): Conversely, when oil prices are moderate, businesses' costs of production are lower. This decreases the cost of producing goods and services and positively impacts the AS curve. Shift the AS curve to the right, showing an increase in aggregate supply (AS1).
Now, let's analyze the impacts on the macroeconomy:
1. Higher Oil Prices:
- Output (GDP): Due to the decrease in aggregate supply, the equilibrium output level decreases. The new equilibrium point (B) will have a lower real GDP value.
- Price Level: As the cost of production rises, businesses pass on those costs to consumers, leading to higher prices. Therefore, the price level increases in the new equilibrium.
2. Moderate Oil Prices:
- Output (GDP): With an increase in aggregate supply, the equilibrium output level increases. The new equilibrium point (C) will have a higher real GDP value.
- Price Level: As production costs decrease, prices become more competitive and may lower. Therefore, the price level decreases in the new equilibrium.
So, higher oil prices influence both the supply and demand side of the economy. The decrease in aggregate supply leads to a decrease in output (GDP) and an increase in the price level. However, when oil prices are moderate, increased aggregate supply results in an increase in output (GDP) and a decrease in the price level.
I hope this explanation helps you with the AS/AD diagram and understanding the impact of oil prices on the US macroeconomy! If you have any further questions, feel free to ask.