Cause and Effect of Oil Price

Oil has become one of the essential resources for an economy to rely on. As all the activities carried in the world today uses oil as their resource the demand for oil is increasing day by day. As oil price increases the inflation rate increases along the way. Oil and inflation move along in the same direction due to cause and effect. Most of the countries buy oil in huge quantities and save it up and thereby adjust the demands as it occurs. But a few countries do not have the infrastructure to keep the oil in reserve. So has the demand increases the price increases and those countries are forced to buy at a high cost. Oil price is a critical factor as it is used for transportation and heating homes. If the oil prices increases the input cost increases for all the products and thus it becomes costly to produce the end product, forcing the companies to increase the price. For a logistics company if the oil price goes up then the fuel price also increases along, as oil is the main input to produce fuel. The company has to increase the cost for logistics, as they cannot bear the expenses for the increase cost. The customers pay this cost at the end. So it makes it hard for a normal person to bear these expenses and thus restricting customers to invest or buy any products at the time of inflation (Wissner Aaron, 2007). This reduction is investments leads to less flow of money in the economy making it harder for the manufacturers to maintain their operating costs as the sales also reduces giving them less income. All these factors affect a common man in this world. When inelastic state of demand for Oil is caused consumers buy the product to a certain point when the price increases. Certain customers change to a cheaper substitute and seek to change their lifestyle and as they are not willing to afford it anymore.

Example of that is in India cars run using petrol or diesel; usually in India petrol prices are 40% higher than diesel prices. When the price of petrol increases at a certain point consumers get fed up of paying more for petrol and finally they pretend to change their car to a diesel model and thus consumers use a cheaper substitute (Wissner Aaron, 2007). But there are a few consumers who love to drive petrol cars due to the comfort and these consumers no matter how much the price increases they do not get affected by it and continue to consume petrol. There is a relation between oil supply, demand, inelasticity, inflation and unemployment. When the demand curve or the supply curve intersects at the point of equilibrium either curves shifts downward from vertically up and the other vertically upward from being horizontal. This is the concept behind inelasticity of oil price. When the demand curve moves faster than the supply curve to the left due the demand in oil then prices and unemployment increases and thus this causes inflation. Inelastic demand and supply curve

Sources: Economic Armageddon.

(n.d.). Retrieved from

http://www.erepublik.com/en/article/economic-armageddon-or-how-the-hell-willwe-ever-recover--1210977/1/20

When all the countries get a glimpse that demand for oil is nearing in the future, these countries tend to book future contracts for supply of oil. These when done by bidding the price of oil increases leading to increase of price in the future date as well as at the current situation. This is also a reason behind increase in oil price. When inelastic demand for oil increases it becomes difficult to control the price and therefore it is increased. These prices in turn affects the economy by leading to the increase of the price of commodities, unemployment rate and this is called inflation, which effects an economy to its worst (Cooke Ron). During inflation investments by the industries are less, flow of money becomes limited, as price is more than the value for any product at this stage. Oil is required to make fuel, heat the house, run vehicles, fly aeroplanes and all other such activities. In the year 2003 when America invaded Iraq oil price per barrel was about $25, but 5 years later the price of oil per barrel was $100. We believe, and I
believe experts will agree, that the war is one of the factors contributing to the increase in the price of oil. And the increase in the price of oil is one of the factors contributing to the weakening of the economy" (Moran Michael). All the activities carried by a country will affect the economy in some way or the other. An increase in oil price could affect the economy in the following ways As oil price increases the fuel prices increases along with it as there is no other choice for the manufacturers of fuel. This affects a consumer by making them pay more towards fuel, as it is an important resource for their day-to-day activities. When consumers spend more on fuel, they tend to decline their expenses on other spendings (Economic Effects). They will tend to change

their behavior of buying other products to buying of cheaper products as their income is spent more on fuel. Therefore all the products manufactured in the economy tend to get wasted or income will be reduced. This will show a huge impact on the economy and will weaken it. When the price of oil increases all the industries will have a problem as their basic resources is fuel for their operations it may be for transportation or any other such activities . When their input cost increases they cannot charge the increment cost to the customers. Instead they strategies on decreasing the operating cost by reducing employee salary, lay offs, reducing the output of the company and other such activities. When this is done then the unemployment rate increases, income of an individual is reduced and finally the economy gets into a weaker position leading to inflation (Economic Effects).

The causes of high oil price are due to the demand and increase in consumption of oil products. At certain periods natural disasters like hurricane and other such disasters lead to destruction of oil tanks and reservoirs and this leads to shortage of causing increase in oil price. All prices are also driven due to the change in dollar rate. Since all the oil trading is done is American Dollars, a reduction in dollar rate would weaken the currency thus leading to increase in the oil price.

OPEC is an organization, which comprises of 13 countries, which make it to 48% of oil supply in the world (How Does OPEC). OEPC is known as The Organization of Petrol Exporting Countries. The main objective of OPEC is to main the oil price to $70

per barrel. If the oil price goes below a certain point, OPEC tends to reduce the production of oil in order to increase the price per barrel (What Makes Oil). Conclusion Therefore from the above information it is very clear that there is a relation between increase in oil price and inflation. Since oil is a resource from the earth it is limited and at a certain point it is possible for oil to be finished within the earth with the amount of oil being consumed. Oil is the most essential resource of an economy and country. It is very important to save oil and limit the consumption of oil by traveling in public transport instead travelling by car. There is a fact which states that Americans drive 3 trillion miles a year which is equal to 820 trips between Pluto and the sun but the Americans believe the demand for oil is consumed more by India and China which causes demand (Hoe Does OPEC). Therefore it is the responsibility of all the citizens of all the countries to ensure that oil is consumed and preserved for future, as oil may not be available for the future generation.

Reference

How does OPEC affect oil price. (n.d.). Retrieved from http://www.wisegeek.com/howdoes-opec-influence-gas-prices.htm

What makes oil prices so high?. (n.d.). Retrieved from http://useconomy.about.com/od/commoditiesmarketfaq/p/high_oil_prices.htm

Economic effects of high oil prices. (n.d.). Retrieved from http://205.254.135.24/oiaf/aeo/otheranalysis/aeo_2006analysispapers/efhop.html

Moran Michael. (n.d.). Total cost of Iraq war hinges on oil question. Retrieved from http://www.msnbc.msn.com/id/23638400/ns/businessstocks_and_economy/t/total-cost-iraq-war-hinges-oil-question/

Wissner Aaron. (2007, April 18). Peak oil, economics 101, and the worst depression. Retrieved from http://valuesystem.livejournal.com/12433.html

Cooke Ron. (n.d.). The elasticity of oil production and consumption. Retrieved from http://www.energybulletin.net/node/27600