op oil exporter Saudi Arabia is expected to hike its prices for all crude grades it sells to Asia-Pacific
in November/December 2019 after an attack on its oil facilities led to a spike in Middle East
benchmarks in October 2019, industry sources said. Assume that the Australian economy starts at
the natural level of output and suppose that this is a permanent increase in the relative price of oil:

a) In an AS−AD diagram (explaining what lies behind the aggregate supply and demand curves)
explain the effect on short-run output. (8 marks)

b) Using the wage-setting and price-setting diagram (explaining the intuition behind the curves),
show what happens to the unemployment rate in the medium run. (7 marks)

c) Show what happens to output and the price level and inflation in the medium run if the RBA has
a price target. (8 marks)

d) How would your answers in (b) and (c) change for an economy experiencing the liquidity trap
problem. (7 marks )