Discuss How Rising Oil Prices Might Affect the Macroeconomic Performance of an Economy

682 Words Dec 27th, 2014 3 Pages
Discuss how rising oil prices might affect the macroeconomic performance of an economy. (25 marks)

There are four main macroeconomic objectives of the government it wishes to achieve in order to maximise the welfare of the society, they are: low and stable inflation, a favourable current account position on the balance of payments, low unemployment and sustained economic growth.
One macroeconomic objective that might be affected by rising oil prices is the current account of the balance of payments. The current account is a record of the trade in goods and services, income flows, and current transfer. The balance of payments is a record of the financial transactions over a period of time between a country and its trading partners.
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As consumption is a component of AD, the AD curve will shift leftwards from AD1 to AD2.With inflation devaluing money, workers will likely ask for higher wages so that their real disposable incomes will be the same as previously before prices rose. This would also mean firms’ costs of production will rise causing the SRAS curve is shift leftwards, this will likely lead to a fall in investment from firms into research and development due to the lack of business confidence, so less new products will be created and produced, potentially slowing down economic growth. This will shift the LRAS curve and AD curve leftwards, as investment is a component of AD and economic growth is represented by LRAS (factors of production).

However, in the economy of an oil-exporting country, AD will likely be high due to high profits when exporting oil to foreign consumers. This would mean that there will be an increase in the balance of trade due to an increase in (X-M) causing the AD curve to shift rightwards causing demand pull inflation. In order to produce more output to meet the increased demand, firms are forced to bid for increasingly scarce resources, raising their costs. They therefore require a higher price to be willing to supply more. With exports rising, the price elasticity of demand is low and there is a relatively small decrease in quantity demanded for oil. Therefore export revenue will probably rise, resulting in an improvement on the current account.

Overall the
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