Final answer:
In the short-run, an increase in government purchases would typically raise aggregate demand and lead to inflation, whereas a large increase in the price of oil acts as a supply shock, potentially leading to higher prices but lower output and employment. In the long run, from a neoclassical perspective, output tends to return to potential GDP with flexible wages and prices, reducing the impact on the price level.
Step-by-step explanation:
When analyzing the effect of an increase in government purchases and a simultaneous large increase in the price of oil on key economic variables, in the short-run, while the economy is in long-run equilibrium, we would expect different impacts on aggregate demand (AD) and aggregate supply (AS). An increase in government spending typically shifts the AD curve to the right, indicating an increased demand across all levels of the price. This would generally increase output and employment, leading to inflationary pressures.
However, a large increase in the price of oil can act as a negative supply shock. This shock would likely shift the short-run Keynesian aggregate supply curve (SRAS) to the left, suggesting that the production costs have increased. In this case, the cost-push inflation would lead to higher overall prices but can potentially result in lower output and employment.
Combining these two effects, we can conclude that the net impact would depend on which effect is stronger. However, if we consider the neoclassical perspective in the long run, the increased demand from government spending may only have transient effects on output and employment. Over time, with flexible wages and prices, the output would adjust back to potential GDP, but with some downward pressure on the price level due to the wage adjustments.