1. A temporary change in the price of oil can affect an economy in many ways. Here we will model a decrease in the price of oil using the aggregate demand-aggregate supply model. Our shock in this question will be: the price of oil temporarily declines, holding all else constant.

Let's start with assuming the US was producing at the full-employment level of output (Yp) with an arbitrary price level (P) before the decline in oil prices.

1. Represent the US economy at this point with an aggregate demand-aggregate supply graph. Label this initial equilibrium as point A.

1. The price of oil decreases like mentioned above. Assuming this was the only change in the economy, show how this affects the short-run equilibrium in your diagram in part a. Label this new point as point B.

1. According to your diagram, is this economy in an expansion or a recession? Explain.

1. Is the economy experiencing stagflation? Why or why not?

1. Assuming there is no government intervention and all prices are eventually flexible, what will happen in the long run? Be specificand talk about how your entire diagram in part a would change.

1. Show this change on your diagram in part a. Label the new point as point C.