Question: Question 4: IS, MP and Philips Curve. ...... . . .... 10 points Consider an economy initially at its potential output. Suppose there is a

Question 4: IS, MP and Philips Curve. ...... . . .... 10 points Consider an economy initially at its potential output. Suppose there is a sudden increase in oil prices (ie. cost push inflation). (a) (5 points) Explain how this would be reflected in the Philips curve diagram. (b) (5 points) How would this affect real interest rates in the IS-MP diagram, and how should the Fed react? (Hint: This part is not straightforward. As a starting point for your analysis, ask yourself what do you see happen to the output gap, if any, in part (a).)

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