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IAI Actuarial Core Principles · Business Economics · Recent macroeconomic history

The 1973-74 oil price rise is best analysed in AD-AS terms as which of the following for an oil-importing economy?

The oil price rise was an adverse supply shock: higher energy costs shifted short-run aggregate supply to the left. The result was a higher price level and lower output in oil-importing economies, which explains simultaneous inflation and recession rather than a demand-driven change.

  1. AA rightward shift of aggregate demand only, raising output and prices
  2. BA leftward shift of short-run aggregate supply, raising the price level and lowering outputCorrect
  3. CA rightward shift of long-run aggregate supply, lowering prices
  4. DA leftward shift of aggregate demand only, lowering prices and output
  5. A rightward shift of short-run aggregate supply, raising output and lowering prices

Explanation

Higher oil prices raised input costs for firms, shifting short-run aggregate supply left. This pushes the price level up and output down, which is the stagflationary outcome. A demand-only shift cannot raise prices and lower output together.

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