Starting from long-run equilibrium, a sharp drop in oil prices results in ________ output in the short run and ________ output in the long run.
A)higher; higher
B)higher; potential
C)lower; potential
D)lower; higher

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 higher output. As a result of this expansionary gap, inflation will gradually start to increase again, thereby shifting the SRAS line back up. When inflation has again risen enough, the economy is back in long-run equilibrium at the same level of output - the potential level of output.

Starting from Long-Run Equilibrium, a Sharp Drop in Oil Prices