An oil cartel effectively increases the price of oil by 100 percent, leading to
ID: 1232168 • Letter: A
Question
An oil cartel effectively increases the price of oil by 100 percent, leading to an adverse supply shock in both Country A and Country B. Both countries were in long-run equilibrium at the same level of output and prices at the time of the shock. The central bank of Country A takes no stabilizing-policy actions. After the short-run impacts of the adverse supply shock become apparent, the central bank of Country B increases the money supply to return the economy to full employment.a. Describe the short-run impact of the adverse supply shock on prices and output in each country.
b. Compare the long-run impact of the adverse supply shock on prices and output in each country.
Explanation / Answer
In both Country A and Country B, output will decline and the price level will rise. In the long run, output in both Country A and Country B will return to the full-employment level, but the price level will be higher in Country B than in Country A because of the policy accommodation.
In the short run, output would decrease with little change in prices. In the short run, unemployment will increase. In the long run, output will return to the full-employment level at a lower price level.