Question

True or False. If the price of oil suddenly increases by a large amount, AS will shift left, but the price level will not rise thanks to price inflexibility.

Short answer

The statement is false.

Step-by-step solution

Meaning and shifts in the aggregate supply

Aggregate supply is the price level for the output at a given output level, which the suppliers receive.In different words, it is the total output supplied in the economy worth the price level.

A change in productivity or production costs (input prices) shifts the aggregate supply curve. A decrease in aggregate supply will create cost-push inflation in the economy. On the contrary, an increase in aggregate supply will pull the economy towards full employment and price stability.

Reason for the false statement.

An increase in oil prices by a significant amount will shift the AS curve to the left because of the increased input costs for the U.S. economy. Due to the leftward shift of the AS curve, the price level will rise.

The prices are flexible upward, so the price level will not be stuck at the initial level by the leftward shift in the AS curve. That’s why the oil prices increased in 1973, causing the infamous oil-price shocks of the 1970s.