Suppose oil prices rise and short-run aggregate supply decreases. If the Fed responds by increasing the quantity of money, then in the short run
A) real GDP increases and the price level rises still higher.
B) the Fed is more concerned about fighting inflation than unemployment.
C) real GDP increases and the price level falls.
D) None of the above answers is correct.

Question

Quizplus · Accepted Answer

When oil prices rise, the cost of production increases, causing the short-run aggregate supply (SRAS) to decrease. This leads to a decrease in real GDP and an increase in the price level. If the Fed responds by increasing the quantity of money, it will lead to an increase in aggregate demand (AD). This will cause both real GDP and the price level to increase further. Hence, choice A is the correct answer.

Suppose Oil Prices Rise and Short-Run Aggregate Supply Decreases