Estimation of Direct and Indirect Impact of Oil Price on Growth - Assignment Example

The world oil price has risen for many years, but recently the price of oil has fallen substantially Contents Introduction 3 Question 3 Question 2 9 Conclusion 13 References 15 Introduction The oil prices have significantly increased for many years. But in the recent years it has been observed that the oil prices are decreasing significantly. The price of oil has decreased by more than 50%. It has significantly influenced the economy by reducing the transportation cost. The fall in the oil prices have affected both favourably as well as unfavourably towards the growth of the economy. The positive impact of fall in oil price in the economy is that it results in lowering the rate of inflation and it also results in increasing the level of output in the economy. The fall in oil prices is favourable for the importers while it is unfavourable for the exporters. The movement in the price of oil is affected or influenced by the change in the demand and supply. When the consumption of oil is more as compared to the production of oil in the economy, then the price of oil will rise and conversely when the consumption of oil is less than the production of oil in the economy then the price of oil will fall or decrease. With the continuous decrease in the price of oil, the production of oil may fall significantly which will result in deflation in the economy. The price of oil is mainly determined by the actual demand and supply in the economy. The prime or the main reason for the fall in the oil price in the economy is the excessive amount of shale that is produced in United States. The fall in the oil price will increase the debt burden of the economy which will result in lowering the economic growth and development of the country or the nation. The fall in the oil prices will benefit the oil consuming countries of the world. Question 1 Impact of fall in oil price on the exporters The fall in the oil price has adversely affected the oil exporting countries of the world since many of the exporters of oil mainly depends on the revenue that is generated from tax charged on the production or manufacture of oil in the economy in order to provide adequate fund for the government spending. The fall in the oil price will result in the deficit budget of the government that will either require decrease in the government spending or increase in the tax rates. The fall in the oil price will result in the creation of social problems as well as budget deficit in the economy. Problems related to increase in supply of oil The main reason for fall in the oil price in the economy is due to oversupply of oil in the economy. The main fall or the decrease in the oil prices in the economy is due to the increase in the interest rates in the economy, increase in the rate of unemployment, disruption in the countries that exports oil, increase in the debt defaults etc. The decrease or the fall in the oil price in the economy has lowered the investment and the consumer spending and it has increased the debt burden in the economy since it is very difficult to decrease the debt to its GDP ratio. The fall or the decrease in the oil price will provide benefit to the consumers with the increase in the discretionary income. But it will also lower the extent or the level of confidence of the consumers. The fall in oil price will result in loss in the economy as compared to the benefit that it will provide in the economy. The economic impact of the fall in the oil prices in the economy is that it will decrease the extent of profitability for producing various alternative sources of energy (Abeysinghe, 2001). The fall in the oil prices can be explained with the help of the diagram given below: Figure 1: Crude oil prices (McEachern, 2008) Few year back the price of oil was increasing significantly but it has fallen in the recent years. The fall in the oil price in the economy has resulted in the situation of the increase in the debt burden deflation and decrease in the growth rate of the economy (Dervis, 2015). Demand and supply theory Change in the price of oil has resulted in the shift of demand and supply curve. Both the demand and supply of oil are considerably inelastic in the short run. The change in the price of oil is related to the quantity supplied and the quantity demanded. When the price of oil increases, the consumers try to adjust their habit according to the increase in the price of oil by reducing their level of consumption. The activities such as exploring drilling and finding out new ways can consume much time and therefore the quantity demanded and the quantity supplied changes according to the increase and decrease in the price of oil. This can be explained with the help of the following diagram. Figure 2: Elasticity and price of oil. The figure represents that since the quantities are fixed in the short run therefore any shift in the supply and the demand will result in the change in price of oil. The decrease in the supply will result in the shortage of oil temporarily but it will start rising in the future period of time. When the demand is elastic a small rise in the price of oil will result in cutting the price of the consumers that is required to meet the level of output. When the demand is inelastic, the increase in price of oil will result in decrease of the quantity demanded. This elasticity of demand and supply can be explained with the help of the diagram given below Figure 3: Elasticity and Inelasticity of Demand (Abel and Ben, 2005) Opportunity Cost: The decrease in the price of oil has increased the opportunity cost since the decrease in the price of oil will lead to the conservation of nature. The nations can get rid of the distorting subsidies and also transferring it’s towards the use of carbon. The use of more reliable, greener and cheaper energy future can be achieved. Analysis of fall in oil prices with the help of demand and supply curve The oil price fluctuates significantly. The price of the oil is determined by the interaction of demand and supply in the economy. The supply curve mainly deals with the quantity and the price of oil that the producers are willing to produce and sell. Figure 4: Shift in supply curve of Oil (Arnold, 2008) When the supply curve changes towards the right there is an increase in the supply of oil prices and when the supply curve moves towards the left there is a decrease in the supply. The decrease in the supply represents that less will be supplied for each amount of price. In the present scenario the supply curve has shifted towards the right which indicates that the price of oil has decreased with the increase or the oversupply of oil in the economy. This will affect the production of oil in the economy since if the prices are low then the producer will decrease the level of production in order to decrease the marginal cost of production whereas if the price of oil are high then the producer will attempt to increase the level of production increases since the marginal cost that is associated with production also increases. The demand curve represents the price and the quantity of oil price for the consumers of the oil that are willing or eager to buy. Figure 5: Shift in demand curve of oil (Gottheil, 2013) The economic growth is considered as the important factor for the shift in the demand curve. Since the demand of oil is inelastic therefore it can be explained as the percentage change in the demand for oil is less as compared to the percentage change in the price of the oil when the value of the price elasticity of oil ranges between 0 and 1. The decrease in the demand for oil will reduce the price of oil in the economy and as a result the fall in the oil price will lead to the delay in the investment. Question 2 Analyze the externalities that may arise from the consumption of oil. The externalities for the consumption of oil include both positive and negative externalities. The negative externalities that are associated with the consumption of oil mainly include the spill over effects that arise from the consumption and production of oil. Negative Externalities related to the environment. The negative externalities mainly affect the consumption and the production as it affects the third parties that are related to the demand and supply of oil in the economy. The externalities related to hydraulic fracturing that is global in nature. The other negative externalities are emission of green house gases that results in polluting or change in the climate or the atmosphere. The externalities mainly occur in case of the situations where the property rights that include the resources and the assets are not assigned and allocated. The BP oil spill over can be taken as an example which explains the externalities that has resulted from the accident due to the failure in maintaining of integrity, the loss of control of the well. The main reason or the cause of the spill over is due to the fact that it has resulted from the eight catastrophic failure which has caused the explosion and has destroyed the deepwater horizon that is drilling in the gulf of Mexico and has resulted in the death of more than 11 people. The BP oil spill is considered as the largest oil spill in the world. The fire has burned 36 hours prior to the sinking of the rig and has resulted in the leakages of the hydrocarbon into the Gulf of Mexico before they were sealed and closed (Sakir, 2014). Negative Externalities related to economy. The other negative externalities that are associated with the economy are the decrease in the oil price in the recent years which have resulted from the oversupply of oil in the economy as well as increase in the demand in the economy has lead to the increase in the inflation in the economy. The oil exporting countries of the world has encountered huge amount of loss due to the fall in the oil prices in the economy and it has forced the oil producing companies to shut down their businesses. The increase in the level of inflation in the economy has resulted in the decrease of the gross domestic product and its growth in the economy. The generation of revenue of the oil exporting countries has decreased and the debt obligations have increased significantly as result this has created problem for the economy thus affecting negatively towards its growth and development (Jiménez-Rodríguez, and Sánchez, 2005). Positive externalities related to the economy. The positive externalities that are related to the economy are that the fall in the oil price has benefitted the importing countries in decreasing the cost of living and it has also resulted in lowering the inflation, decrease in the rate of tax and there cost of transport (Zhao, 2014). Steps taken by government to influence the consumption of oil Government can use the spending and taxing power that it has in order to promote stable and sustainable growth of the economy. Fiscal policy is referred to as the use of spending and taxation by the government so as to endorse strong and long term growth and to reduce poverty at the same time. The role and objective of the fiscal policy achieved eminence during the current worldwide economic crisis (Horton and El-Ganainy, 2012). It was during the global financial crisis that the governments through fiscal reforms in order to support the financial systems, jumpstart economic growth and also to reduce the impact of economic crisis on certain sectors. Recently the role of Fiscal policy of the government as a way to influence consumption and its effects on the economy was looked down upon. More prominence was given to the market forces and the forces of supply and demand. However that view has changed post the financial crisis. In ca\se of an oil producing country, policymakers may try and align the fiscal policy with respect to the border macroeconomic development. This can impact the procyclical spending in the oil producing countries that is the tendency of the oil producing countries to increase their spending when oil prices are higher and lower the spending when oil prices are lower. Government can if it wills increase or decrease the consumption of oil. In order to decrease the consumption of oil it can try to create better infrastructure for mass transportation, ensure better safeguards in producing oil, push for reforms that seek to reward companies in producing energy efficient vehicles etc. In order to reduce the externalities that are associated with the environment mainly implementation of the regulation that is related to the environmental protection, the government has issued various permits that will control the amount or the extent of pollution in the economy. There is probability of the fall in the supply of oil which will result in the situation of oil shortage in the economy as a result the demand of oil is likely to increase in the future. The economic growth that is related with various outcomes and consequences are supposed to increase favourably with the rise in the stock market and the supply of capital in the economy. This acts as a positive factor in functioning of the economy. The government has attempted to decrease the price of oil since the decrease in the oil price has positive and favourable affect on the economy. Since the supply of oil is directly related with the economy therefore the government has focused on decreasing the supply of oil in the economy (Sexton, 2007). The control over the fluctuations of oil price in the economy will provide better and adequate resistance in the economy. The demand for oil in the economy is required to be increased in such a way that it will affect positively towards the growth and development of the economy and it will provide stability in the price of oil in the economy. The intention of United States in undertaking fluctuations of oil prices in the economy is required to be restricted. In recent years however it was noted that there was significant fall in prices of oil. While falling oil prices is taken as a good sign by the countries who import oil, it is taken as a bad sign for the exporters of oil (US department of Energy, 2015). If the oil prices fall then the importing countries will be benefited as the transportation cost will reduce. This will lead to the direct reduction in the transportation costs and thereby reduction in the inflation levels. One of the main reasons behind the fall in Europe’s inflation in recent times is due to the fall in the prices of oil. However the impact of the oil exporters on the falling prices of oil is negative. Many of the oil producing countries depend on the tax revenue from the oil export. For example in Russia 70% of the tax revenue in generated by collecting taxes from oil. The government can intervene in the form of introducing subsidy or to impose taxes in other sectors so as to recover the taxes and help it to stimulate growth. The government can additionally increase the expenditure so that the demand for oil can be boosted. This is because the fall in oil consumption shows that the economic growth is also on the decline. This is not a good sign and if this leads to deflation then it is a serious macroeconomic problem. Hence the government must intervene to boost economic growth and thereby boost the demand for oil. Conclusion The oil price has increased significantly in the past years but in the recent years it has been observed that the price of oil has fallen significantly as a result it has affected both favourably and adversely some of the countries of the economy as a whole . The fall in the oil prices has affected favourably the oil importing countries of the world but it has affected negatively and adversely the oil exporting countries of the world since the fall in the oil prices has increased the extent and the amount of debt obligation of the importing countries. The decrease in the oil prices has affected different nations in different ways. The decrease in the oil prices has resulted due to the fall in the demand and the oversupply of oil in the economy. The decrease in the oil price has lead to the situation of inflation in the economy and the further decrease in the oil price will result in the situation of recession in the economy and hence it will be very difficult for eradicating the problems and controlling the economy. The decrease in the oil price is due to the situation of disequilibrium between the supply and demand of oil in the economy. The consumption of oil has undergone various positive as well as negative externalities both in the perspective of the environment as well as the economy and therefore it is required by the government to take necessary steps and measures for reducing the externalities and maintaining stability of the oil price in the economy. The decrease in the oil price in the economy will result in the increase in the debt defaults and it will create constraint for the shale drillers in paying off their loans. The fall in the oil price is considered as the result or the consequences of inefficient global demand. The continuous decrease in the growth rate will affect the demand of oil in the economy. Therefore the price of oil is required to be stabilized. References Abel, A. and Ben, B., 2005. Macroeconomics. London: Pearson Education. Abeysinghe, T., 2001. Estimation of direct and indirect impact of oil price on growth. Economics letters, 73(2), pp. 147-153. Arnold, R.A., 2008. Macroeconomics. Mason: South Western Cengage Learning. Dervis, K., 2015. The Oil Price Opportunity [Online].Available at: < http://www.globalpolicyjournal.com/blog/27/01/2015/oil-price-opportunity>. [Accessed 21 April 2015]. Gottheil, F. M., 2013. Principles of Microeconomic. Mason, OH: South Western Cengage Learning. Horton, M., and El-Ganainy, A., 2012. Fiscal Policy: Taking and Giving Away. [Online]. Available at < http://www.imf.org/external/pubs/ft/fandd/basics/fiscpol.htm > [Accessed 21 April 2015]. Jiménez-Rodríguez, R., and Sánchez, M., 2005. Oil price shocks and real GDP growth: empirical evidence for some OECD countries. Applied economics, 37(2), pp. 201-228. McEachern, W.A., 2008. Macroeconomics: A Contemporary Introduction: A Contemporary Introduction. Mason, OH: South Western Cengage Learning. Sakir, S., 2014. The Consequences of falling oil prices. [Online].Available at: : < http://www.huffingtonpost.ca/salman-sakir/falling-oil-prices_b_6292224.html > [Accessed 21 April 2015]. Sexton, R.L., 2007. Exploring Economics. Mason, OH: South Western Cengage Learning. US department of Energy., 2015. Reduce Oil Dependence Costs. [Online]. Available at < https://www.fueleconomy.gov/feg/oildep.shtml > [Accessed 21 April 2015]. Zhao, T., 2014. Economic and political drivers behind the drop in international oil prices. [Online].Available at: < http://carnegietsinghua.org/2014/12/18/economic-and-political-drivers-behind-drop-in-international-oil-prices >. [Accessed 21 April 2015]. 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