A sudden, permanent drop in oil prices is best described as what type of shock?

A sudden, permanent drop in oil prices is best described as what type of shock?

• A. Demand shock
• B. Supply shock
• C. Both
• D. None of the above

Answer: (B)

The key idea is distinguishing where the disturbance comes from: supply versus demand. A sudden, permanent drop in oil prices changes production costs across many firms—oil is a major input—so it’s a supply-side change. When input costs fall, producers are willing to supply more at every price, shifting the short-run aggregate supply curve to the right. This tends to lower the overall price level and raise real GDP in the short run. It’s not a demand shock, which would come from a change in spending behavior (consumption, investment, etc.) rather than from production costs. So the scenario is best described as a supply shock.

The key idea is distinguishing where the disturbance comes from: supply versus demand. A sudden, permanent drop in oil prices changes production costs across many firms—oil is a major input—so it’s a supply-side change. When input costs fall, producers are willing to supply more at every price, shifting the short-run aggregate supply curve to the right. This tends to lower the overall price level and raise real GDP in the short run. It’s not a demand shock, which would come from a change in spending behavior (consumption, investment, etc.) rather than from production costs. So the scenario is best described as a supply shock.