Fluctuating Price of Oil and How It Affects the Global Economy

5248 Words Apr 11th, 2013 21 Pages
Fluctuating price of oil and how it affect the global economy
The oil prices have started rising significantly since the initiation of the twenty first century.
Theoretically, one can judge the impact of an oil price shock. The immediate effect of the oil price shock is the increased cost of production due to increased fuel cost. This creates an inflationary effect (mainly cost push inflation which is accompanied by a situation of unemployment). Whenever there is an overall inflation in the economy, the cost of production would also rise causing a decrease in supply. On the other hand, inflation implies a fall in the purchasing power of people. In short, oil price fluctuation has adverse effects on the economy.
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Apart from these, the responsiveness of gas prices to oil prices, the intensity of use of gas in the economy and effect of increasing oil prices on the prices of other alternative sources of energy, electricity etc. influences the extent of the direct impact of hike in oil prices on a country’s economy. The higher the level of increase in oil prices, the longer will be the peri od for the sustainability of highe r prices and as a result, it will lead to larger impact on important macroeconomic variables which are used to determine the performance of the economy. (Lee, Ni, and Ratti, 1995; Mundell, 1968; Jones, Donald Leiby, and Paik, 2004)
For oil exporting countries, real GDP is incr eased by oil-price hike through increase in higher earnings from exports. However, in later period, in most of the cases, a part of this gain in
GDP would be offset by the reduction in demand for exports from the importing countries because of the poor economic condition of these tr ading partners. This is because hike in oil prices actually leads to increase in prices of other commodities too. (Mundell, 1968; Jones,
Donald Leiby, and Paik, 2004)

Apart from the immediate effects just discussed above, some indirect or adjustment effects also take place after a rise in oil prices. These adjustment effects generally result from the
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