Inflation and Oil Prices Inflation refers to the persistent increase in the price level over time and is one of the most dangerous threats to an economy because, if left unchecked, it will erode the purchasing power of a currency and if the country's monetary system is destroyed, it may ultimately force individuals to adopt foreign currency. There are two types of inflation: demand-push inflation and cost-push inflation. when inflation persists in the economy due to the initial decrease in aggregate supply caused by an increase in the relative price of an important factor of production, namely labor and energy. The 1970 oil crisis is an apt example of cost-push inflation (supply shock). Answer 1) Short-run aggregate supply is the relationship between real GDP and the price level. In other words, it shows how much the economy can produce in the short run. An increase in the level of oil prices in the short term will force producers to reduce the supply of oil in the economy. The following diagram will adequately explain the effect of rising oil prices on short-run aggregate supply: SRAS''SRASQuestion. The figure above shows that when the price of oil rises, producers shift supply backwards due to high input prices. As a result, real GDP decreases and the price level increases and a serious stagflation situation is created. Answer 2) The increase in oil prices will also be a serious concern for consumers. Working on the law of demand, as the price of oil increases, consumers of oil-related products, such as gasoline, will reduce their demand at higher prices. As a result, their oil consumption for driving, combustion and production will be reduced. (Prasodjo) Answer 3) As we already have... half of the document...... DP and unemployment levels. The AS-AD model shows a negative relationship between the level of inflation and unemployment. In other words, with supply shocks due to rising oil prices, there is a decline in the GDP rate and this increases unemployment rates. So rising oil prices will not only lead to high inflation but also high unemployment and reduced economic growth. This same effect is shown in the Philips curve. (Parkin)Works CitedFederal Reserve bank of San Francisco. What are the possible causes and consequences of rising oil prices on the general economy. November 2007. Web. December 14, 2013. Parkin, Michael. “Inflation, Unemployment, and Business Cycles in the United States.” Institute, CFA. Economy. Boston: Custom, 2011. 188-210. Print.Prasodjo, Darmawan. Oil Price Analysis: Supply, Demand and Futures Trading. December 2013. Web. 14 December 2013.