2. Throughout much of the 1990s, the United States experienced declining energy prices. Assume that the U.S. economy was in long-run equilibrium before these declines began.

a. Use the aggregate demand-aggregate supply model to illustrate graphically the short-run and long-run impact of this decline on output and prices. In other words how does the economy get back to long run, explain. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the terminal equilibrium values. State in words what happens to prices and output as a combined result of the supply shock, both in the short run and long run. What happens to unemployment rate in the short run and in the long run?

b. If the Federal Reserve attempted to offset this deviation from the natural rate in the short run, should the money supply be increased or decreased? Show this action in the same graph and label the shifts. Which curve shifts? Does it shift to the right or left? What happens to output and prices as a result? What happens to unemployment rate? Explain.