The Crude Art of Policy Making
Assignment 3.1 MM 204 Economic Analysis
Lessons: The Crude Art of Policy Making All over the world, the price of crude oil experiences wide price swings in times of shortage or oversupply just like other commodities. The crude oil cycle may extend over several years responding to changes in demand and supply. In this paper, we intend to discuss the dynamics and impact in the economy, and how the central banks respond to a rise in oil price. To be able to understand the dynamics of adjustment of oil price, we use the economic diagram of aggregate demand and supply given by D1 and S1 respectively in the left hand graph, where the points they intersect signify that the economy is in equilibrium. In the graph, Q1 is the output at the natural level of output and implies the price, P1. Based on the graph, the shift on aggregate supply curve to the left, to S2 is caused by the firm who imports crude Graph1. The impact of higher oil prices. oil. If the price of importing crude oil is high, then the firm’s production costs will also increase. As a result, it reduces profit so they supply fewer goods and services. This can also relate according to Blanchard, using the equation: P = Pe (1+μ) F(1- u,z) where, u = unemployment rate μ = mark up of the price over nominal wage Pe = expected price level
In this equation, given the Pe, the increase in the price of oil shows an increase in the mark up, μ. The increase in the mark up will lead the firms to increase their prices, leading to an increase in the price level, P, at any level of output, Q. Then, the aggregate supply curve shifts up or move to the left. In addition, the aggregate demand curve also moves left, to D2. The increase in the price of oil leads the firms to increase their price which decrease the demand and output. As a result, the consumers would be resulted in lower rates of consumption due to increase in the price level. Thus, economy suffers both a negative supply shock and negative demand shock. Over
Lessons: The Crude Art of Policy Making All over the world, the price of crude oil experiences wide price swings in times of shortage or oversupply just like other commodities. The crude oil cycle may extend over several years responding to changes in demand and supply. In this paper, we intend to discuss the dynamics and impact in the economy, and how the central banks respond to a rise in oil price. To be able to understand the dynamics of adjustment of oil price, we use the economic diagram of aggregate demand and supply given by D1 and S1 respectively in the left hand graph, where the points they intersect signify that the economy is in equilibrium. In the graph, Q1 is the output at the natural level of output and implies the price, P1. Based on the graph, the shift on aggregate supply curve to the left, to S2 is caused by the firm who imports crude Graph1. The impact of higher oil prices. oil. If the price of importing crude oil is high, then the firm’s production costs will also increase. As a result, it reduces profit so they supply fewer goods and services. This can also relate according to Blanchard, using the equation: P = Pe (1+μ) F(1- u,z) where, u = unemployment rate μ = mark up of the price over nominal wage Pe = expected price level
In this equation, given the Pe, the increase in the price of oil shows an increase in the mark up, μ. The increase in the mark up will lead the firms to increase their prices, leading to an increase in the price level, P, at any level of output, Q. Then, the aggregate supply curve shifts up or move to the left. In addition, the aggregate demand curve also moves left, to D2. The increase in the price of oil leads the firms to increase their price which decrease the demand and output. As a result, the consumers would be resulted in lower rates of consumption due to increase in the price level. Thus, economy suffers both a negative supply shock and negative demand shock. Over