n 1973 the Organization of Petroleum Exporting Countries (OPEC) raised the price of a barrel of oil by 400% and some Arab members placed an oil embargo on countries (i.e. the United States) which supported Israel in the ‘Yom Kippur’ war against Egypt and Syria. Show in the AS-AD model the impact of this event on a developed oil-importing country and consider the best policy response to stabilise the economy at a long run equilibrium position.

The AS-AD model, or Aggregate Supply-Aggregate Demand model, is a macroeconomic model that explains price level and output through the relationship of aggregate demand and aggregate supply. It's used to illustrate the effects of shocks on the economy, such as the 1973 oil crisis.

Step 1: Identify the initial equilibrium Before the oil crisis, the economy is at equilibrium where Aggregate Demand (AD) equals Aggregate Supply (AS) at a certain price level and output.

Step 2: Analyze the shock The 400% increase in oil prices and the oil embargo is a negative supply shock. This is because oil is a major input in production and a rise in its price increases the cost of production for businesses, reducing the quantity of goods and services they can supply at each price level.

Step 3: Illustrate the shock in the AS-AD model In the AS-AD model, this negative supply shock is represented by a leftward shift of the AS curve. This leads to a new equilibrium with a higher price level (inflation) and lower output (recession), a situation known as stagflation.

Step 4: Consider the policy response To stabilize the economy, the government could use expansionary fiscal policy (increase government spending or decrease taxes) to shift the AD curve to the right, or use expansionary monetary policy (lower interest rates) to increase investment and consumption. However, these policies could exacerbate inflation. Alternatively, the government could use supply-side policies to shift the AS curve back to the right, such as investing in alternative energy sources or improving energy efficiency to reduce dependence on oil.

Step 5: Illustrate the policy response in the AS-AD model The chosen policy response would shift either the AD or AS curve (or both) to restore the economy to its long run equilibrium position at the potential level of output and stable price level.

Remember, the best policy response would depend on the specific circumstances of the country and the trade-offs it is willing to make between inflation and unemployment.