Explain the impact of an increase in oil prices on UK economic growth and inflation.
Initially we are at an equilibrium where AD1 is equal to SRAS1 giving rise to a Price Level of PL1 and a level of Real Output of Y1. The increase in oil prices would raise production costs across the economy due to, for example, the rising cost of fuel and energy. This has the impact of shifting the SRAS curve upwards. A new equilibrium is now formed where AD1 is equal to SRAS2. At this new equilibrium there is a higher price level of PL2 and a lower level of Real GDP of Y2. In other words, the economy would experience cost-push inflation and a fall in the rate of economic growth. We know that the inflation is cost-push as supposed to demand-pull as the inflation is as a result of a rising production costs (upward shift in SRAS) as supposed to rising levels of Aggregate Demand.
