Draw the initial long run equilibrium using AD-AS diagram. Now suppose a positive supply shock such as afall in oil price happens.

a. Show the effect of this positive shock in the output market as well as on the short run and long run Phillips Curve diagram. Label the points in both diagrams clearly. If you label point A on one diagram, show point A on the other to demonstrate the situation of unemployment and inflation on the Phillips curve diagram too.

b.Show (on the diagrams you drew above) how the economy will adjust in the long run if Bank of Canada uses expansionary monetary policy (increasing money supply). What happens to inflation and unemployment?

c.Show what happens if the BoC uses contractionary monetary policy (decreasing money supply). What happens to inflation and unemployment? Draw a new set of diagrams to show this effect. Clearly show points A, B and C on both the diagrams.