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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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Ohio Wesleyan UniversityGoran Skosples11. Oil Shocks of the 1970s and the Great Depression
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.
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.
The oil price shock shifts SRAS ____, causing output and employment to ___.
In absence of further price shocks, prices will ___ over time and economy moves ______________ ______________.
Predicted effects of the oil shock:
…and then a gradual recovery.
As economy was recovering, oil prices shot up again, causing another huge supply shock!!!
A favorable supply shock--a significant fall in oil prices.
As the model predicts, inflation and unemployment ______:
What is the prediction about interest rates?
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.
Output Growth Rate (%)
Nominal Money Stock
55.3The Great Depression
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 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
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
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.