There were two major shocks to the U.S. economy in 2007, leading to a severe economic

Chapter 0, Problem 10

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There were two major shocks to the U.S. economy in 2007, leading to a severe economic slowdown. One shock was related to oil prices; the other was the slump in the housing market. This question analyzes the effect of these two shocks on GDP using the ADAS framework. a. Draw typical aggregate demand and short-run aggregate supply curves. Label the horizontal axis Real GDP and the vertical axis Aggregate price level. Label the equilibrium point E1, the equilibrium quantity Y1, and equilibrium price P1. b.Data taken from the Department of Energy indicate that the average price of crude oil in the world increased from $54.63 per barrel on January 5, 2007, to $92.93 on December 28, 2007. Would an increase in oil prices cause a demand shock or a supply shock? Redraw the diagram from part a to illustrate the effect of this shock by shifting the appropriate curve. c. The Housing Price Index, published by the Office of Federal Housing Enterprise Oversight, calculates that U.S. home prices fell by an average of 3.0% in the 12 months between January 2007 and January 2008. Would the fall in home prices cause a supply shock or demand shock? Redraw the diagram from part b to illustrate the effect of this shock by shifting the appropriate curve. Label the new equilibrium point E2, the equilibrium quantity Y2, and equilibrium price P2. d.Compare the equilibrium points E1 and E2 in your diagram for part c. What was the effect of the two shocks on real GDP and the aggregate price level (increase, decrease, or indeterminate)?