Spending Program and Oil Shock
The question
Assume the economy of Kalmyra is initially in long-run equilibrium. This year the government begins a large expansion of its purchases of goods and services that was written into law three years earlier for reasons unrelated to events abroad, and in the same year a conflict overseas doubles the world price of oil, a key input for producers throughout Kalmyra. Assume the central bank takes no action and that Kalmyra's quantity of resources and level of technology are unchanged. Show the short-run effect on Kalmyra's economy, holding all else constant. Show the effect on the AD-AS Model graph.
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Spending Program and Oil Shock: the worked answer
On the AD-AS Model graph, AD shifts right and SRAS shifts left.
Why AD shifts right and SRAS shifts left
Higher government purchases raise total spending at every price level, so aggregate demand shifts to the right. The oil shock raises firms' per-unit production costs across the economy, so at every price level firms are willing to supply less output and short-run aggregate supply shifts to the left. Neither event changes the quantity of resources or the level of technology, so long-run aggregate supply does not move. Both shifts push the price level up, so the price level definitely rises. They push output in opposite directions, because the rightward AD shift raises real GDP while the leftward SRAS shift lowers it, so the change in real GDP is indeterminate and depends on which of the two shifts is larger.
What happens to the equilibrium
The price level definitely rises, while real GDP is indeterminate: it increases if the spending expansion is the larger shift, decreases if the cost shock is, and is unchanged if the two offset.
The mistake students make on this one
Students typically answer "the price level rises and real GDP rises" because they lead with the fiscal expansion, or they answer stagflation with output definitely falling because they lead with the oil shock. Both output claims are guesses. The spending increase and the cost increase push real GDP opposite ways, so only the price level can be signed, and picking a winner between the two shocks requires magnitudes the stem never supplies.
On exam day
When AD and SRAS shift in opposite directions, the price level is the determinate outcome and output is not, so earn the point by writing that real GDP is indeterminate and naming the relative size of the two shifts as the reason.
How this is graded
The checker reads every curve's position before and after your answer. You are marked correct only when AD shifts right and SRAS shifts left and every other curve on the AD-AS Model graph stays where it started — the same standard an AP reader applies to a drawn graph: the right shift, and nothing extra. There is no AI involved; the rubric is the geometry.
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