Question

49. 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.

Answer 1

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.