3.

a. Analyze the effects of a temporary increase in the price of oil (a temporary adverse supply shock) on current output, employment, the real wage, national saving, investment, and the real interest rate. Because the supply shock is temporary, you should assume that the expected future MPK and households’

expected future incomes are unchanged. Assume throughout that output and employment remain at full-employment levels (which may change).

b. Analyze the effects of a permanent increase in the price of oil (a permanent adverse supply shock) on current output, employment, the real wage, national saving, investment, and the real interest rate. Show that in this case, unlike the case of a temporary supply shock, the real interest rate need not change. (Hint: A permanent adverse supply shock lowers the current productivity of capital and labor, just as a temporary supply shock does. In addition, a permanent supply shock lowers both the expected future MPK and households’ expected future incomes.)