Suppose the economy is in full employment equilibrium. Then a positive supply shock, caused by a fall in oil prices, hits the economy. A contractionary monetary policy will

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A positive supply shock, such as a fall in oil prices, increases supply, leading to lower prices and potentially higher output. A contractionary monetary policy, aimed at reducing inflation or stabilizing prices, would decrease the money supply, increasing interest rates, and potentially lowering demand. This combination moves the economy back to full employment output but at a lower price level than before the shock, as the policy counters inflationary pressures from increased output.

Suppose the Economy Is in Full Employment Equilibrium