8 . Economic fluctuations II

The following graph shows the short-run aggregate supply curve (AS), the aggregate demand curve (AD), and the long-run aggregate supply curve (LRAS) for a hypothetical economy. Initially, the expected price level is equal to the actual price level, and the economy is in long-run equilibrium at its natural level of output, $120 billion.

Suppose war in the world's main oil-producing region sharply reduces the world oil supply, causing oil prices to rise and increasing the costs of producing goods and services in this economy.

Use the graph to help you answer the questions about the short-run and long-run effects of the increase in production costs that follow. (Note: You will not be graded on any adjustments made to the graph.)

Hint: For simplicity, ignore any possible impact of the higher oil prices on the natural level of output.