Understanding Aggregate Supply?

Question

Understanding Stagflation....

In 1974, oil prices suddenly increased dramatically and the economy experienced an adverse supply shock. CETERIS PARIBUS..... What happened to the price level & real GDP? Why is this sometimes called stagflation?

Answer 1

The normal economic business cycle is that inflation rates tend to rise when GDP growth accelerates and the economy approaches near the potential GDP capacity constraint, while inflation rates fall as stagnation and recession begin with aggregate demand weakening and GDP growth decelerates and even turns negative. So, inflation goes with raid economic expansion while falling prices/ inflation go with economic stagnation and decline in growth rates of GDP. However, in the 1970s after the first major supply shock for petroleum oil  when the OPEC cartel capped oil production and raised prices sharply, the US and many other economies had witnessed a long period of slowdown in growth rates and stagnation in GDP at around the same level in the US and some other countries. It was a period showing the unusual combination of stagnant GDP growth and rising/ high inflation simultaneously. That is why that period is said to be one of Stagflation (stagnation- inflation combined together)