Suppose that the money prices of raw materials increase so that short-run aggregate supply decreases. If the Federal Reserve does not respond, the higher money price of raw materials will
I. repeatedly shift the aggregate demand curve rightward and raise the price level.
II. shift the aggregate demand curve rightward and the aggregate supply curve leftward, raising prices.
III. result initially in lower employment and a higher price level.

Question

Quizplus · Accepted Answer

If the Federal Reserve does not respond to the increase in money prices of raw materials, in the short-run, the aggregate supply will decrease leading to higher prices and lower employment (as firms produce less). This is depicted by the leftward shift in the short-run aggregate supply curve. The aggregate demand curve should not shift repeatedly rightward and raise the price level as stated in option I, as the leftward shift in short-run aggregate supply will outweigh the increase in aggregate demand, leading to higher prices and lower output. The option II, where both aggregate demand and aggregate supply curve shifts rightward, is incorrect as the leftward shift in aggregate supply is definite, only due to which there is a rise in prices.

Suppose That the Money Prices of Raw Materials Increase So