Use the classical (RBC) IS—LM—FE model to show the effects on the economy of a temporary beneficial supply shock; for example, a decrease in the price of oil

You should show the impact on the real wage, employment, output, the real interest rate, consumption, investment, and the price level.


The marginal productivity of labor is increased, shifting the labor demand curve to the right. As a result, the real wage rises and employment increases. Both the higher productivity and increased employment increase output. The FE line shifts right, with the IS curve unchanged, so the LM curve must shift down (the price level declines) to restore equilibrium. As a result, the real interest rate declines, increasing consumption and investment.

Economics

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What are the main rules of the Budget Enforcement Act of 1990?

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