Question 2: A Second Look at the Oil Crisis In this question, we analyze the 1973 oil crisis using the AD-AS model. Starting from October 1973, the 12 members of the Organization of the Petroleum Exporting Countries (OPEC) stopped selling oil to the United States. Within a few months, oil prices increased by about 400%. Assume the economy was in a long-run equilibrium before the onset of 1973 oil crisis. Denote the full-employment level of output and the price level before the onset of 1973 oil crisis as Youd and Paid, respectively. We interpret the increase in oil prices as a decrease in productivity. In response to the increase in oil prices, firms immediately set higher prices for their products (so we assume Special thanks to Robert Jackman, Rafael Lopes de Melo, John Grigsby, Xiaoxuan Meng, Wataru Miyamoto for sharing questions upon which this problem set is based. Problem Set #5 Econ 2220 - Fall 2022 that the price is not sticky even in the short run). As a consequence, output fell more than the full-employment level of output did in the short run. Denote the new full-employment level of output after the crisis as Ynew. For the following questions, please label the original equilibrium point A, indicate the directions in which the curves shift, and label the new equilibrium point B. Your answers have to be no more than 5 sentences excluding graphs. 1. Explain what happened to the US economy in the short run due to the increase in oil prices using the AD-AS diagram. What happened to output and the price level in equilibrium in the short run? What happened to the short-run and long-run aggregate supply (SRAS and LRAS) curves, and the aggregate demand curve (AD)? 2. Suppose the central bank would try to offset the effect of higher oil prices on output in the short run. Specifically, the central bank would set the real interest rate so that output in the short run would remain at the full employment level of output before the onset of 1973 oil crisis (Yoda). (a) Due to the central bank's intervention, what would happen to the equilibrium in the short run in the AD-AS diagram? What would happen to the AD/SRAS/LRAS curves? Explain using the AD-AS diagram. (b) Due to the central bank's intervention, what would happen to the equilibrium in the long run in the AD-AS diagram? Especially, what would happen to the price level in the long run? Compare the price level to the one in the case without intervention. Assume output level would be equal to the new full-employment level (Fnew) in the long run. Explain using the AD-AS diagram. 3. Suppose the central bank would try to offset the effect of higher oil prices on the price level. Specifically, the central bank would set the real interest rate so that the long-run price level would remain at the level before the onset of 1973 oil crisis (Para)- (a) Due to the central bank's intervention, what would happen to the equilibrium in the short run in the AD-AS diagram? Especially, what would happen to output in the short run? Compare the output level to the one in the case without intervention. What would happen to the AD/SRAS/LRAS curves? Explain using the AD-AS diagram. (b) Due to the central bank's intervention, what would happen to the equilibrium in the long run in the AD-AS diagram? Assume the output level would be equal to the new full-employment level (Ynew) in the long run. Explain using the AD-AS diagram