Question

Suppose an economy starts at its long-run equilibrium point. Then three changes happen at the same time: • Interest rate goes down • Government expenditures increase • Oil price increases What happens to the price level (P) and the quantity of production (Q) just after the above changes?

A) both P and Q certainly go up

B) P certainly goes up, but Q may or may not go up

C) Q certainly goes up, but P may or may not go up

D) P and Q both may go up or down, depending on the relative magnitude of the changes

Answer 1

B is correct

Increase in government expenditure and decrease in interest leading to increase in investment spending, increase aggregate demand leading to increase in price and quantity.

Increase in oil prices decreases aggregate supply leading to decrease in quantity and increase in price.

At equilibrium price increases but change in quantity is indeterminant.