Question

Suppose that there is a temporary, but significant, increase in oil prices in an economy with an upward-sloping SRAS curve.

a. If policymakers wish to prevent the equilibrium price level from changing in response to the oil price increase, should they increase or decrease the quantity of money in circulation? Why?
b. If policy makers wish to prevent equilibrium real GDP from changing in response to the oil price increase should they increase or decrease the quantity of money in circulation? Why?
c. Can policymakers stabilize both the price level and real GDP simultaneously in response to a short-lived but sudden rise in oil prices? Explain briefly.

Answer 1

a. If policymakers wish to prevent the equilibrium price level from changing in response to the oil price increase, they should decrease the quantity of money in circulation because that will put a check on demand of oil in the market which will prevent the equilibrium price rise.

b. If policy makers wish to prevent equilibrium real GDP from changing in response to the oil price increase then the key is to control inflation.In order to do that, money circulation should be decreased so that the demand of oil could lower down and inflation remains in check.

c.Yes, it is possible to stabilize both the price level and real GDP simultaneously in short run because firms possess fixed factors like prices and capital and other factors of production.If policymakers need to stabilize prices and real GDP then inflation should be controlled by decreasing money circulation quantity so that other fixed factors of production firms like capital or wages could be used in order to keep the prices stable for short term.