Answers
A. The increasing price of oil will result in decrease in GDP. That will increase unemployment. The aggregate price level will also increase.
This is known as stagflation and is an inflation issue.
B. The government has two options. It can either increase the real GDP to previous level, or lower the price level, but it cant do both. This is shown in the graph below.
The government can increase its spending to increase GDP, but that will drive prices higher.
It can otherwise reduce its spending, increase taxes etc- resulting in lower output but same price.
C. These are considered dilemmas because, as discussed above, in case of supply shocks- the government can only solve one issue- price or GDP, at one time. In fact, solving for one usually makes the other even worse.
LRAS Aggregate price level SRASZ SRAS P2 AD2 Real GDP
.
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