The US economy is at full employment when the world price of

The U.S. economy is at full employment when the world price of oil begins to rise sharply. Explain how this will affect the aggregate Supply in the short-run, prices of goods and services, and real GDP in the US

Solution

Monetary policy: This is the policy of government regarding the money supply in the market. Objective of this policy is to regulate the supply of money in the market by controlling interest rates, purchasing or selling bonds, etc.

The strengths of monetary policy are the interest rates and bonds. Monetary easing policy means the policy for increasing money supply in the market. More money in the market might be required for increasing production, employment opportunity, and growth. It could be done by lowering interest rates, by purchasing bonds from the open market, or by printing currency notes. All these are activities of the government. Therefore, the government should be allowed for easing the monetary policy to promote economic growth.

Monetary policy action: Flow of money should be increased in the market to cope up the oil price crisis. It could be done by reducing interest rates, and purchasing securities from open market. Once this is done the supply crisis will be over by increasing production. It reduces the price level and increases the real GDP.