Since Fall of 2013, the price of oil has shown a steady decline as continued inc
ID: 2506571 • Letter: S
Question
Since Fall of 2013, the price of oil has shown a steady decline as continued increase of global oil production that has far exceeded the rising demand for oil. Accordingly, many analysts in the energy field have had predicted the likelihood of further decline in oil price in the US market as the US continues to expand its domestic oil production with a long term objective of becoming even net exporter of oil by Y2030. Read some articles in the web on Shale Oil Production in the US and its future. Given the significant trend of declining oil price and expected independence of oil production by US in coming decade, draw an AS/AD diagram of macroeconomics model (not the oil market itself), explaining the effect on the US macro-economy of expected decline in oil price in 2014 and beyond. In your explanation in words with the help of the diagram, you must clearly explain the connection between changes in oil price and the fluctuations in macroeconomic fundamentals in the US economy. Then show the impact of continuous fall in oil price on the US economy by using the same AD-AS model during the recovery period of the economy from its great recession of 2008. The most recent price of crude oil is fluctuating within the range between $100 and $105/barrel.
Finally, explain why sharp decline in oil prices might not necessarily have positive or negative impact on the US equity markets (stock market) even at the current trend of declining but volatile oil prices
Explanation / Answer
Crude oil is an important and widely used source of energy in the United States. United States is
not only one of the biggest producers of Oil but it also imports Oil to full fill its energy needs.
When oil price falls, it becomes good news for domestic producers because their cost of
production will fall. However, it becomes bad news for the domestic producers of oil as their
surplus will fall. Ignoring the impact on domestic producers of oil, the fall in oil price would
cause aggregate supply (and hence RGDP) to increase in the economy because with decline in
cost of production, domestic producers would be producing more. As a result domestic price
level will fall. Conversely, if oil prices are increasing, cost of production will increase and hence
there will be negative impact on domestic production (and on RGDP) as producers would be
producing less units of output. As a result domestic price level will increase. This situation has
been represented in figure1 below:
Figure1:
The continuous fall in oil price actually helped the economy to revive faster during the recovery
period of the economy from its great recession of 2008. The fall in oil price provide incentive to
the producer to produce more as they would