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Ohio Wesleyan University Goran Skosples 11. Oil Shocks of the 1970s and the Great Depression PowerPoint Presentation
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Ohio Wesleyan University Goran Skosples 11. Oil Shocks of the 1970s and the Great Depression. Two case studies: Oil shocks of the 1970s The Great Depression. Supply shocks. A supply shock alters production costs, affects the prices that firms charge. (also called ____ shocks )

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Presentation Transcript
slide2
Two case studies:
  • Oil shocks of the 1970s
  • The Great Depression
supply shocks
Supply shocks

A supply shock alters production costs, affects the prices that firms charge. (also called ____ shocks)

Examples of adverse supply shocks:

Bad weather reduces crop yields, pushing ____ __________.

Workers unionize, negotiate ______________.

New environmental regulations require firms to reduce emissions. Firms ________________ to help cover the costs of compliance.

Favorable supply shocks _______ costs and prices.

case study the 1970s oil shocks
CASE STUDY: The 1970s oil shocks

Early 1970s: OPEC coordinates a reduction in the supply of oil.

Oil prices rose 11% in 1973 68% in 1974 16% in 1975

Such sharp oil price increases are supply shocks because they significantly impact production costs and prices.

case study the 1970s oil shocks1
CASE STUDY: The 1970s oil shocks

The oil price shock shifts SRAS ____, causing output and employment to ___.

LRAS

P

SRAS1

AD

Y

In absence of further price shocks, prices will ___ over time and economy moves ______________ ______________.

A

A

case study the 1970s oil shocks2
CASE STUDY: The 1970s oil shocks

Predicted effects of the oil shock:

inflation __

output __

unemployment _

…and then a gradual recovery.

case study the 1970s oil shocks3
CASE STUDY: The 1970s oil shocks

Late 1970s:

As economy was recovering, oil prices shot up again, causing another huge supply shock!!!

case study the 1980s oil shocks
CASE STUDY: The 1980s oil shocks

1980s:

A favorable supply shock--a significant fall in oil prices.

As the model predicts, inflation and unemployment ______:

slide9

CASE STUDY: The 1970s oil shocks

What is the prediction about interest rates?

exercise
Exercise

An oil cartel effectively increases the price of oil by 100 percent, leading to an adverse supply shock in both Country A and Country B. Both countries were in long-run equilibrium at the same level of output and prices at the time of the shock. The central bank of Country A takes no stabilizing-policy actions. After the short-run impacts of the adverse supply shock become apparent, the central bank of Country B increases the money supply to return the economy to full employment.

a. Describe the short-run impact of the adverse supply shock on prices and output in each country.

b. Compare the long-run impact of the adverse supply shock on prices and output in each country.

exercise1

r

r

LM0(M0/P0)

LM0(M0/P0)

r0

r0

IS1

IS1

Y

Y

Y0

Y0

LRAS

LRAS

P

P

SRAS0

SRAS0

Po

Po

AD0

AD0

Y

Y

Y0

Y0

Exercise

B

A

the great depression

U.S. Unemployment, Output Growth, Prices, and Money, 1929 to 1942

Year

UnemploymentRate (%)

Output Growth Rate (%)

Price Level

Nominal Money Stock

1929

3.2

9.8

100.0

26.6

1930

8.7

7.6

97.4

25.7

1931

15.9

14.7

88.8

24.1

1932

23.6

1.8

79.7

21.1

1933

24.9

9.1

75.6

19.9

1934

21.7

9.9

78.1

21.9

1935

20.1

13.9

80.1

25.9

1936

16.9

5.3

80.9

29.5

1937

14.3

5.0

83.8

30.9

1938

19.0

8.6

82.2

30.5

1939

17.2

8.5

81.0

34.1

1940

14.6

16.1

81.8

39.6

1941

9.9

12.9

85.9

46.5

1942

4.7

13.2

95.1

55.3

The Great Depression
shocks to the is curve
Shocks to the IS curve

an exogenous fall in the demand for goods & services – a leftward shift of the IScurve.

Stock market crash  exogenous C

Oct-Dec 1929: S&P 500 fell 17%

Oct 1929-Dec 1933: S&P 500 fell 71%

Drop in investment

“correction” after overbuilding in the 1920s

widespread bank failures made it harder to obtain financing for investment

Contractionary fiscal policy

Politicians raised tax rates and cut spending to combat increasing deficits.

a shock to the lm curve
A shock to the LM curve

a huge fall in the money supply.

evidence: M1 fell 25% during 1929-33.

The relation between the money stock, M1, and the monetary base (physical money) is given by:

M1 = monetary base x money multiplier

a shock to the lm curve1
A shock to the LM curve

but, P also fell 25% during 1929-33.

 the effect on the LM curve should be neutral

What was the problem then?

recall: r = i -  e

how e shifts the lm curve

r

r

LM2

LM1

L(i-2e,Y1)

L(i-1e,Y1)

Y

M/P

Y1

How e shifts the LM curve

(a) The market for real money balances

(b) The LM curve

r2

r2

r1

r1

M1/P1

e

_r (for the same i)

_ L 

__LM

the effects of falling prices

r

P

LM0(M0/P0)

r0

IS0

Y

Y

LRAS

SRAS0

P0

AD0

Y0

The effects of falling prices

r = i -  e

  • IS AD shifts __

Y1Y0  P

  • LM should shift __
  • but, M   LM const
  • AD shifts ___
  • At the same time
  •  P e
  •  eLM shifts ___
  • AD shifts ___

Result:

 __ P, __ Y, __ r

Y0

why another depression is unlikely
Why another Depression is unlikely

Policymakers (or their advisors) now know much more about macroeconomics:

The Fed knows better than to let __ fall so much, especially during a contraction.

Fiscal policymakers know better than to raise ______ or cut __________ during a contraction.

Federal deposit insurance makes widespread bank failures very unlikely.

Automatic ___________ make fiscal policy expansionary during an economic downturn.