Answer to Question #277706 in Macroeconomics for ZUU

Question

An increase in the price of oil is an example of a negative supply shock. Use the AD-AS model graph to explain the effect of a negative supply shock on the price levels and output levels in the economy

Answer 1

This diagram shows a negative supply shock. The first position is at point A which is producing output quantity Y₁ at price P₁. In this case occurrence of supply shock is an increase in the price of oil which has an adverse effect on aggregate supply thus supply curve shifts left, from AS₁ to AS₂, and the demand curve remains in the same position. Supply and demand curves intersection has moved and equilibrium is at point B. The price level has increased to P₂ and quantity has reduce to Y₂.