This solution was written by a subject matter expert. It’s designed to help students like you learn core concepts.
Creating a diagram to illustrate the short-run equilibrium of an economy experiencing shocks like a surge in oil prices and a stock market crash in 2022 can be complex but insightful. Here’s how you can visualize and understand it:
1. Initial Equilibrium: Start with an aggregate demand (AD) curve and an aggregate supply (AS) curve intersecting at a point, representing the initial equilibrium. This point marks the original levels of output (GDP) and the price level.
2. Oil Price Shock: The sudden increase in oil prices is a negative supply shock. It shifts the AS curve to the left (from AS to AS1). This happens because higher oil prices increase production costs for many businesses, reducing the overall supply of goods and services at each price level.
3. Stock Market Crash: The stock market crash impacts aggregate demand. It shifts the AD curve to the left (from AD to AD1). A stock market crash reduces wealth and consumer confidence, leading to decreased spending and investment.
4. New Equilibrium: The intersection of the new AD1 and AS1 curves represents the new short-run equilibrium. This point will be at a lower GDP level, indicating a reduction in economic output, and at a higher price level, indicating inflation (a phenomenon known as stagflation).
5. Impact on Unemployment: The lower level of GDP (economic output) in the new equilibrium suggests higher unemployment. This is because businesses are producing less and may need fewer workers.
6. Price Level Changes: The price level increases (inflation) despite the economic downturn due to the cost-push inflation from higher oil prices and reduced supply.
Remember, this is a simplified representation and actual economic scenarios can be influenced by various other factors and policy responses. The diagram would have AD and AS curves, with shifts to the left for both curves, leading to a new equilibrium with lower GDP and higher price levels.