Suppose there is a temporary but significant increase in oil prices in an economy with an upward-sloping Short-Run Aggregate Supply (SRAS) curve. If policymakers wish to prevent the equilibrium price level from changing in response to the oil price increase, should they increase or decrease the quantity of money in circulation? why?

Suppose there is a temporary but significant increase in oil prices in an economy with an upward-sloping Short-Run Aggregate Supply (SRAS) curve. If policymakers wish to prevent the equilibrium price level from changing in response to the oil price increase, should they increase or decrease the quantity of money in circulation? why?

To determine whether policymakers should increase or decrease the quantity of money in circulation to prevent changes in the equilibrium price level in response to an increase in oil prices, we need to understand the relationship between money supply and price levels.

In an economy with an upward-sloping SRAS curve, an increase in oil prices leads to an increase in production costs for firms. As a result, firms are likely to reduce their output and increase prices, leading to a higher price level. Policymakers can influence price levels by adjusting the quantity of money in circulation.

To prevent the equilibrium price level from changing, policymakers should decrease the quantity of money in circulation. Here's why:

1. Increase in oil prices: If the economy experiences a temporary but significant increase in oil prices, production costs for firms will rise. This leads to a leftward shift of the SRAS curve, indicating a decrease in aggregate supply. As a result, the equilibrium price level will rise.

2. Quantity of money: By adjusting the quantity of money in circulation, policymakers can influence demand in the economy. When there is more money available, consumers can spend more, increasing aggregate demand. Conversely, reducing the money supply limits consumers' purchasing power, leading to a decrease in aggregate demand.

3. Impact on aggregate demand: If policymakers increase the quantity of money in circulation, it will lead to an increase in aggregate demand. With higher aggregate demand, firms will be able to sell their products at higher prices, exacerbating the inflationary pressures caused by the increase in oil prices. This would lead to a further increase in the equilibrium price level.

4. Stabilizing price level: To prevent the equilibrium price level from changing, policymakers should decrease the quantity of money in circulation. By reducing the money supply, policymakers can help counterbalance the inflationary pressures caused by the increase in oil prices. Lower aggregate demand would put downward pressure on prices, helping to stabilize the price level.

In summary, to prevent changes in the equilibrium price level resulting from an increase in oil prices in an economy with an upward-sloping SRAS curve, policymakers should decrease the quantity of money in circulation. This helps counterbalance the inflationary pressures by reducing aggregate demand and stabilizing the price level.