14. In the accompanying diagram, the economy is in long- run macroeconomic equilibrium at point E when an oil shock shifts the short-run aggregate supply curve to SRAS2. Based on the diagram, answer the following questions. LRAS Aggregate price level SRAS2 SRAS1 E1 P1 AD1 Y1 Real GDP a. How do the aggregate price level and aggregate output change in the short run as a result of the oil shock? What is this phenomenon known as? b. What fiscal or monetary policies can the govern- ment use to address the effects of the supply shock? Use a diagram that shows the effect of policies cho- sen to address the change in real GDP. Use another diagram to show the effect of policies chosen to address the change in the aggregate price level. c. Why do supply shocks present a dilemma for gover ment policy makers?

4.1 Why does the short-run aggregate supply curve slope upward? 4.2 Explain why the long-run aggregate supply curve is vertical. Then, (verbally and graphically) explain how each of the following events would affect the long-run aggregate supply curve. a. A lower price levels b. A decrease in the labor force c. A decrease in the quantity of capital goods d. Technological change

31) Use the dynamic model of aggregate demand and supply to illustrate a situation where aggregate demand and short-run aggregate supply are both increasing from year 1 to year 2, resulting in a higher price level and higher level of real GDP at macroeconomic equilibrium in year 2. 32) Hurricane Katrina resulted in a decline in oil production infrastructure along the gulf coast.  As a result there was an unexpected decline in oil and natural gas supplies in 2005.  Suppose that this caused an increase in the price level and a decline in real GDP in 2006.  Also assume that potential real GDP continued to grow due to other factors.  You can assume the aggregate demand curve did not change.  Show the macroeconomic equilibrium for 2005 and 2006 using the dynamic aggregate supply and aggregate demand model. 1

a. Beginning with long-run equilibrium, use the aggregate demand (AD) and aggregate supply (AS) model to explain (and illustrate) what happens in the short run when the economy suffers a negative supply shock. Be sure to detail what happens to aggregate demand, aggregate supply, the price level, the level of GDP, and unemployment.