Answer to Question #158347 in Macroeconomics for Arsalan

Question

Due to COVID-19 situations the oil prices fall in international market. Let’s assume that output starts at its natural level.

a.     What happens to the Pakistan’s economy (output and price) in the short run? Explain your answer using AS-AD graphs.

 

What happens to Pakistan’s economy (output and price) in the long run? Explain your     answers using graphs

Answer 1

When the oil prices fall, there will be lower inflation and higher output. This diagram below indicates that the fall in oil prices result to a shift in short-run aggregate supply (SRAS) towards right, leading to lower inflation and higher real GDP. Oil importers may benefit from falling oil price since the value of their oil imports will drop. The drop of oil price will ideally damage Pakistan’s economy due to reduction in tax revenue from oil production.