The oil shock of 2007-2008 saw the price of oil rising from less than $60 a barrel in March 2007 to over $145 a barrel in July 2008,and decreasing again to just over $30 a barrel in December 2008.Assuming the economy was at potential GDP prior to the oil shock,the decrease in the price of oil,such as what occurred between July 2008 and December 2008,acts as a positive supply shock,causing the inflation rate to ________ and the output gap to ________.
A) increase; grow
B) decrease; grow
C) increase; shrink
D) decrease; shrink

Question

Quizplus · Accepted Answer

A decrease in the price of oil acts as a positive supply shock, causing the cost of production to decrease and shift the aggregate supply (AS) curve to the right. This results in lower prices and higher output, which shrinks the output gap (the difference between actual and potential GDP) and decreases inflation. Therefore, the correct answer is D) decrease; shrink.

The Oil Shock of 2007-2008 Saw the Price of Oil