Consider an economy with a flexible exchange rate that is initially in equilibrium. Click here

Graph the following curves by clicking here

On a graph, draw the aggregate demand curve, as well as the short and long run aggregate supply curves. Label these curves AD1, SRAS1, and LRAS1. Label the initial equilibrium P1 and Y1.

Suppose a sudden and dramatic decrease in a critical imported intermediate good (such as oil) occurs. How does this affect the AD curve? Draw the new curve, labeling it AD2.

How does the change described in part b affect the long and short run aggregate supply curves? Draw the new curves, labeling them SRAS2 and LRAS2.

Label the new long run equilibrium levels of Y and P as Y2 and P2.