If inflation accelerates due to the increase in the price of oil (an import), the best...

If inflation accelerates due to the increase in the price of oil (an import), the best policy to combat such inflation in a country with a high unemployment rate, would be to...

[1] apply the supply-side policy that will increase aggregate supply, which will be illustrated by a rightward shift of the AS curve.

[2] respond with demand management policy that will increase aggregate demand, which will be illustrated by a rightward shift of the AD curve.

[3] implement contractionary monetary policy, illustrated by the rightward shift of the AD curve.

[4] apply incomes policy, illustrated by a leftward shift of the AS curve.

Expert Solution

Option [1].

Higher oil price reduces aggregate supply, shifting AS curve leftward, which increases inflation, decreases output and increases unemployment. A supply side policy that increases aggregate supply will shift AS curve rightward, which decreases inflation, increases output and decreases unemployment.

Note that increasing aggregate demand will increase inflation rate.

Rahul Sunny answered 2 years ago

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