Starting from long-run equilibrium, the long-run impact(s)of a sharp drop in oil prices, compared to the original equilibrium, is(are):
A)higher inflation and the same output.
B)lower inflation and lower output.
C)the same inflation and the same output.
D)higher inflation and lower output.

Question

Quizplus · Accepted Answer

A favorable inflation shock, resulting from lower oil prices, is modeled as a downward shift of the SRAS curve. In the short run, this results in lower inflation and higher output. As a result of this expansionary gap, inflation will gradually start to increase again shifting the SRAS line back up. When inflation has again risen enough, the economy is back in long-run equilibrium at the original level of output and inflation.

Starting from Long-Run Equilibrium, the Long-Run Impact(s)of a Sharp Drop