The aggregate supply and aggregate demand model

Question

The organization of petroleum exporting countries decide to restrict the production of oil causing an adverse supply shock. What happens to an importing country’s price level and income in the short run?

Answer 1

Oil is an input cost for firm. An adverse supply shock for oil will cause the price of oil to rise, which results in higher input costs for firms. As a result of the higher input costs, the short run aggregate supply (SRAS) will decrease. The decrease in SRAS leads to higher price levels and less income in the short run.