Answer to Question #277509 in Management for Gee

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.

(Note: Five marks will be awarded for the graph and five marks will be

awarded for the explanation.)

(10)

Answer 1

An increase in the price of oil leads to a significant change in production cost leading to lower production of oil in barrels and therefore supply of oil also decline. From the graph you will note that the supply curve moves from SRAs to the new SRAs.

Should there be no change in the quantity of oil demanded the oil prices will shift from P1 to P2 leading a fall in output levels in the economy from Y1 to Y2.