The Canadian economy suffered two major shocks in 2008, leading to the severe recession of 2008–2009. One shock was related to oil prices; the other was the slump in the housing market. This question analyzes the effect of these two shocks on GDP using the AD–AS framework.

a. Draw typical aggregate demand and short-run aggregate supply curves. Label the horizontal axis “Real GDP” and the vertical axis “Aggregate price level.” Label the equilibrium point E₁, the equilibrium quantity Y₁, and equilibrium price P₁.

b. Would an increase in oil prices cause a demand shock or a supply shock? Redraw the diagram from part a to illustrate the effect of this shock by shifting the appropriate curve.

c. The New Housing Price Index, published by Statistics Canada, calculates that Canada’s home prices fell by an average of 3.0% in the 12 months between April 2008 and April 2009. Business fixed capital formation fell by 19% during the same period. Would the fall in home prices cause a supply shock or demand shock? Redraw the diagram from part b to illustrate the effect of this shock by shifting the appropriate curve. Label the new equilibrium point E₃, the equilibrium quantity Y₃, and equilibrium price P₃.

d. Compare the equilibrium points E₁ and E₃ in your diagram for part c. What was the effect of the two shocks on real GDP and the aggregate price level (increase, decrease, or indeterminate)?