1) Suppoer the economy is operating at full employment and foreign countries raise the world price of oil. Assuming policy-makers do not take any actions, describe what will happen to prices and output in the short run. How should I answer to this question and which diagram should i use? please give explicit answer...thanks!!! my answer: Oil prices and all prices that are affected by oil will rise. Output will decrease in the short run. Over time compensations will be made and everything will be back to normal with oil usage decreased. how can i extend the answer to like a passage?
As we experienced in USA, consumers did not care till gas prices hit $4/gal. In other words price elasticity for oil starts when gas hits $4/gal and stays there for several months. Yes peakoil is around the corner and once oil rises and gas rises along with it we will see the contraction in economy after gas hits $4/gal. Until then, life goes on.
but to help you out: "production" wont reduce short term (unless you are talking about oil production, which they reduced in order to raise oil prices). Consumption will decrease somewhat in the short term (as a result of the price increase), relative to the elasticity of demand for oil and oil related products & services. The supply curve will shift to the left, and a new equilibrium will be realized at a now higher price. This will drag on the economy as a whole, since most countries' output is dependent on oil and its derivatives. In the long run oil substitutes (which are now relatively more profitable or "less unprofitable") will serve to absorb some of the shortages. Substitutes can include other stuff that behaves like oil, or technologies that conserve and/or do the same amount of work with less oil. For extra credit you could write a blurb about how the sudden scurrying about for conservation and alternative technologies can be a long time boon for the economy, since research and tinkering often does result in innovation and benefits (sometimes even unrelated to the primary focus of the research; take Viagra: I think it was supposed to be a heart disease medicine, and during the field trials the researchers were like "whoa, what's this!!!???!).
inflation of crude oil prices can be considered as a worsening of the Producion function. If with 1 dolar of oil you produce today less than you did yesterday, your production function has worsened.
Completely untrue. 2.50, 3.00. 3.50 gas drove people crazy. A lot of people who had businesses dependent on a lot of fuel like airlines were hard hit by the prices below $4. Try being a trucker when fuel was "just $3.00" Try being someone with a low paying job and you drive 25 miles each way. Or a user of heating oil, when it went from $1.50 to $3 a barrel.