Oil-Price Shocks: Beyond Standard Aggregate Demand/Aggregate Supply Analysis

S. Kirk Elwood

The Journal of Economic Education, 2001, vol. 32, issue 4, 381-386

Abstract: The author explores the problems of portraying oil-price shocks using the aggregate demand/aggregate supply model. Although oil-price shocks are the most commonly cited examples of aggregate supply shocks, they violate the model's assumption of constant relative prices (as acknowledged by the label, “oil-price shocks”). The resulting problems are effectively masked in textbook presentations by implicitly assuming that the supply shocks occur in a closed economy. However, the typical discussion is glaringly inaccurate when discussing the effects of oil-price shocks on oil-rich countries. Thus, the cogency of the standard model's representation of oil-price shocks on open economies is compromised. A simple modification of the model that differentiates between production and absorption goods enables it to better reflect the effects of oil-price shocks on open economies.

Date: 2001
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DOI: 10.1080/00220480109596116

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