Page 239 - Krugmans Economics for AP Text Book_Neat

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Supply Shocks Versus Demand Shocks in Practice
How often do supply shocks and demand in December 2007, and that had lasted for al- the dates of the 1973 Arab–Israeli war, the
shocks, respectively, cause recessions? The most two years by the time this book went to 1979 Iranian revolution, and the 2007 oil price
verdict of most, though not all, macroecono- press, was at least partially caused by a spike in shock marked on the graph. The three highest
mists is that recessions are mainly caused by oil prices. unemployment rates since World War II came
demand shocks. But when a negative supply So 8 of 11 postwar recessions were after these big negative supply shocks.
shock does happen, the resulting recession purely the result of demand shocks, not There’s a reason the aftermath of a supply
tends to be particularly severe. supply shocks. The few supply -shock reces- shock tends to be particularly severe for the
Let’s get specific. Officially there have been sions, however, were the worst as measured economy: macroeconomic policy has a much
twelve recessions in the United States since by the unemployment rate. The figure shows harder time dealing with supply shocks than
World War II. However, two of these, in 1979– the U.S. unemployment rate since 1948, with with demand shocks.
1980 and 1981–1982, are often treated as a
single “double -dip” recession, bringing the total Unemployment
rate
number down to 11. Of these 11 recessions, 1979
12% Iranian revolution
only two—the recession of 1973–1975 and the
double -dip recession of 1979–1982—showed 1973
10
the distinctive combination of falling aggregate Arab–Israeli war 2007
Oil price shock
output and a surge in the price level that we call
8
stagflation. In each case, the cause of the sup-
ply shock was political turmoil in the Middle
6
East—the Arab–Israeli war of 1973 and the
Iranian revolution of 1979—that disrupted
4
world oil supplies and sent oil prices skyrocket-
ing. In fact, economists sometimes refer to the
two slumps as “OPEC I” and “OPEC II,” after the
Organization of Petroleum Exporting Countries, 1948 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
the world oil cartel. A third recession that began (Bureau of Labor Statistics) Year

Module 19 AP Review

Solutions appear at the back of the book.
Check Your Understanding

1. Describe the short -run effects of each of the following shocks 2. A rise in productivity increases potential output, but some
on the aggregate price level and on aggregate output. worry that demand for the additional output will be
a. The government sharply increases the minimum wage, insufficient even in the long run. How would you respond?
raising the wages of many workers.
b. Solar energy firms launch a major program of investment
spending.
c. Congress raises taxes and cuts spending.
d. Severe weather destroys crops around the world.

module 19 Equilibrium in the Aggregate Demand–Aggregate Supply Model 197