Oil prices increase sharply, raising the price level and decreasing real GDP. The Fed has an incentive to

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When oil prices increase, the cost of production increases, which results in a decrease in production and an increase in prices. This leads to a decrease in real GDP, which also means unemployment increases. In such a situation, the Fed has an incentive to increase the quantity of money to reduce the interest rate, which will lead to an increase in investment, production, and employment. Therefore, the best choice is C.

Oil Prices Increase Sharply, Raising the Price Level and Decreasing