Ten Principles of Economics - Part 76. Economics is the study of how society manages its scarce resources. In most societies, resources are allocated not by a single central planner but through the combined actions of millions of households and firms. Economists therefore study how people make decisions: how much they work, what they buy, how much they save, and how they invest their savings. Economists also study how people interact with one another. | CHAPTER 33 THE SHORT-RUN TRADEOFF BETWEEN INFLATION AND UNEMPLOYMENT 775 however the economics profession would turn its attention to a different source of shifts in the short-run Phillips curve shocks to aggregate supply. This time the shift in focus came not from two American economics professors but from a group of Arab sheiks. In 1974 the Organization of Petroleum Exporting Countries OPEC began to exert its market power as a cartel in the world oil market in order to increase its members profits. The countries of OPEC such as Saudi Arabia Kuwait and Iraq restricted the amount of crude oil they pumped and sold on world markets. Within a few years this reduction in supply caused the price of oil to almost double. A large increase in the world price of oil is an example of a supply shock. A supply shock is an event that directly affects firms costs of production and thus the prices they charge it shifts the economy s aggregate-supply curve and as a result the Phillips curve. For example when an oil price increase raises the cost of producing gasoline heating oil tires and many other products it reduces the quantity of goods and services supplied at any given price level. As panel a of Figure 33-8 shows this reduction in supply is represented by the leftward shift in the aggregate-supply curve from AS1 to AS2. The price level rises from P1 to P2 and output falls from Y1 to Y2. The combination of rising prices and falling output is sometimes called stagflation. supply shock an event that directly alters firms costs and prices shifting the economy s aggregate-supply curve and thus the Phillips curve An Adverse Shock to Aggregate Supply. Panel a shows the model of aggregate demand and aggregate supply. When the aggregate-supply curve shifts to the left from AS1 to AS2 the equilibrium moves from point A to point B. Output falls from Y1 to Y2 and the price level rises from P1 to P2. Panel b shows the short-run tradeoff between inflation and unemployment. The adverse .
