Suppose the economy is initially at point A in the diagram below, and there is a sudden increase in oil prices that the central bank believes is only temporary. Which point best depicts where the economy will end up in the short run?
A)A
B)B
C)C
D)D

Question

Suppose the economy is initially at point A in the diagram below, and there is a sudden increase in oil prices that the central bank believes is only temporary. Which point best depicts where the economy will end up in the short run? 
A)A 
B)B 
C)C 
D)D

Quizplus · Accepted Answer

The sudden increase in oil prices is likely to cause a decrease in aggregate supply, shifting the AS curve to the left. This will result in a higher equilibrium price level and lower real GDP. Point C represents this new equilibrium where the economy is experiencing higher inflation and lower output. Points A, B, D, and E are all outside of the new potential equilibrium and do not accurately represent the short-run effects of the supply shock.

Suppose the Economy Is Initially at Point a in the Diagram