Oil Price Shock Effects on Inflation Types

Steps:

• Higher world oil price increases costs for oil-importing country, reducing real income due to inelastic demand (quantity falls little, import spending rises sharply).
• Reduced real income lowers consumer spending and aggregate demand, decreasing demand-pull inflation.
• Higher oil prices raise production costs as key input, shifting aggregate supply leftward and increasing cost-push inflation.
• Net effect: demand-pull inflation falls, cost-push inflation rises.

Why B is correct:

• Matches standard macro: AD shifts left (reduce demand-pull), AS shifts left (increase cost-push) per cost-push inflation definition.

Why the others are wrong:

• A: Demand-pull does not increase; higher costs reduce AD.
• C: Cost-push does not reduce; input costs rise directly.
• D: Identical to C, so cost-push effect is wrong.

Final answer: B