Explain and illustrate the effect of this shock, and the courses of action the Government and the Bank of England are, in your opinion, likely to take as a consequence. Discuss the implications for business of both the initial shock and the following Government and Bank actions. You should assume that the Government of the day has committed itself to full employment, "prudent" public spending, and no major tax increases. The Bank has an inflation target of 2.5% pa.
A long run equilibrium is one in which the aggregate markets ? financial, product and resource, are in equilibrium simultaneously This is made possible by flexible wages and prices and is represented by the intersection of the AD (aggregate demand) curve and the LRAS (long-run aggregate supply) curve. It is important to establish whether the economy is in a long run equilibrium, in order to maintain a ceteris paribus while assessing the speculative increase in the price of oil. By assuming that all other factors are constant, it makes it possible to begin to solve the issues arising through the price rise through a mix of individual and/or grouped solutions.
Oil is a commodity that is deemed demand inelastic. Like many other ?neccessity' goods, a change in price will result in a disproportionately lower change in the demand for the good. (See Fig 1) People and firms would be unable to avoid consuming the same amount of oil in the short term even if there was an increase in its price, due to the fact that there are no available direct substitutes. Manufacturing firms who burn oil for power cannot simply shut off their generators, public buses that run on petrol and diesel products will not discontinue their services and citizens who heat their homes and water with oil will ...