Congratulations! You have been appointed an economic policy adviser to the Unite

Question

Congratulations! You have been appointed an economic policy adviser to the United States. You are told that the economy is significantly below its potential output and that the following will happen next year: World income will fall significantly and the price of oil will rise significantly. (The United States is an oil importer.)

a. What will happen to the price level and output?

Price level increases and output may increase or decrease. Price level may increase or decrease and output decreases. Price level may increase or decrease and output increases. Price level decreases and output may increase or decrease.

Explanation / Answer

As world income decreases, aggregate demand will decrease and AD curve shifts toward left.

As oil price increases, it rises the input costs to production, therefore aggregate supply will also decrease & AS curve will shift toward left.

A leftward shift of AD & AS will both decrease the output. But as AD decreases, price will decrease, but as AS decreases, price will increase. So net effect on price is ambiguous - price may decrease or increase overall.

Correct option (2).

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