In Apr 2020, the WTI crude oil price dropped to a historical low price of -$40/barrel. With an aid of AS-AD diagram, explain the effect on price level and output of the above event.

Since oil is an important raw materials for production, when the oil price drops, the cost of production decreases. So, the short run aggregate supply increases. The price level decreases and the output level increases in the short run.

The inflationary gap will result in an upward pressure on the input prices. In the long run, wages will adjust upward and the SRAS will decrease. The price level and the output will restore to its original level.