a.) This is a supply shock. A decrease in the oil price would lead to a decrease in the aggregate supply. This would lead to a decrease in the output and an increase in the price level in the short run. b.) The central bank can take a contractionary monetary policy to restore the output to natural rate level output. This would lead to a decrease in the price level. Explanation: a. One example of a supply shock is the substantial drop in the price of oil. This is as a result of the fact that the cost of oil is a component that is taken into consideration throughout the production of goods and services in their entirety. A drop in the price of oil will lead to a decrease in the costs of production experienced by companies, which will lead to an increase in the aggregate supply as a result of the chain reaction. This will, in the not-too-distant future, lead to both a rise in output as well as a decline in the general price level. b. The central bank can use expansionary monetary policy to increase the money supply and lower interest rates. If the oil price decreases in Canada, this will lead to a decrease in aggregate demand and output. The central bank can use expansionary monetary policy to increase the money supply and lower interest rates. This will lead to an increase in aggregate demand and output. The impact on the price level will be inflationary.

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