Oil is a key input to the U.S. economy. Describe scenarios in which oil could be involved in each of the following types of shifts: a rightward shift in the short-run aggregate supply (SRAS) curve, a leftward shift in the SRAS curve, a rightward shift in the long-run aggregate supply (LRAS) curve, and a leftward shift in the LRAS.

Question

What will be an ideal response?

Answer 1

The SRAS curve can be shifted by a change in input prices that does not reflect a permanent change in the supply of those inputs. A temporary price decrease in oil would lower production costs for firms making them more willing to increase supply at every given price level, shifting the SRAS curve rightward. A temporary price increase in oil would raise production costs for firms and they would be likely to decrease supply at every given price level, shifting the SRAS curve leftward. Neither of these price changes affects the world capacity or quantity of available oil; thus, they do not affect the LRAS curve. The LRAS curve could be shifted rightward by an increase in the capacity or sustained production of oil. This could occur through the discovery of previously unknown oil fields or the use of innovative technology to dramatically increase production. An oil cartel, such as OPEC, could exert significant control over the world production of oil and increase world oil prices by deliberately reducing oil production. This would effectively create a decrease in available natural resources and shift the LRAS curve leftward.