CFA Level IEconomicsHard
A sudden global increase in oil prices causes a leftward shift in an economy's short-run aggregate supply (SRAS) curve while aggregate demand remains unchanged. What is the most likely short-run effect on the price level and real GDP?
- APrice level decreases; real GDP increases
- BPrice level increases; real GDP decreases
- CPrice level decreases; real GDP decreases
- DPrice level increases; real GDP increases
Show answer & explanationAnswer & explanation
Correct answer: B. Price level increases; real GDP decreases
A negative supply shock (e.g., an oil price spike) shifts SRAS leftward, moving the economy along a stable AD curve to a new equilibrium with a higher price level and lower real output — a condition known as stagflation.
Why the other options are wrong
- A. Describes a rightward SRAS shift, the opposite of this scenario.
- C. Would result from a leftward AD shift, not a supply shock.
- D. Would require an AD increase, not a supply-side shock.
Cost-Push Supply Shock (Stagflation)
A negative shift in short-run aggregate supply caused by rising input costs, leading simultaneously to higher price levels and lower real output.
- Classic trigger: sharp rise in oil/commodity prices
- Combines inflation with recession/stagnation — 'stagflation'
- Contrasts with demand-pull inflation, which raises both price and output
Memory trick: Oil shock = Stag(nation) + (in)flation = Stagflation.