1) Suppoer the economy is operating at full employment and foreign countries raise the world price of oil. Assuming policy-makers do not take any actions,describe what will happen to price and output in the short run and long run.

Question

2) Suppose the Federal Reserve decided it wanted to offset any adverse effects on output. What actions could it take? What would be the consequences for the price level if the Fed used monetary policy to fight unemployment?

3) Economists claim that supply shocks create a dilemma for the Federal Reserve that shocks to demand (for example, from investment) do not create. Explain this point using your answer to (2) and the aggregate demand-and-supply diagram.

4) Economists who believe that the transition from the short run to the long run occurs rapidly do not generally favor active use of stabilization policy. Use the aggregate demand and supply graphs to illustrate how active policy, with a rapid adjustment process, could destablize the economy.

each question needs a diagram to illustrate how it works, can anyone help me to answer the questions please?

Answer 1

1) Start by drawing aggregate supply and demand curves. Oil is generally an input to production. An increase in price should shift the supply curve inward. What happens to price? quantity=GNP? In the long run, supply and demand are more elastic. Redo with more elastic curves.

2) What are the tools the Fed has to control the money supply. For your graph, use IS and LM curves. (The Fed shifts the LM curve). Also use the "quantity theory of money" MV=PQ.

3) The point in 3 is true if "shocks" are always bad (ie. a disruption of supply or demand) Rarely do we worry about "positive" shocks. Since the Fed is in charge of keeping inflation and low, negative supply shocks raise prices, negative demand shock lower prices.

4) What are forms of stabilization policy. And how effective would they be if the economy recovered from shocks very quickly? Would they cause alternative problems? Hint: yes.

Take it from here. Repost if you have specific questions.