The Negative Economic Impacts of Falling Oil Prices on Economy - Assignment Example

The negative economic impacts of falling oil prices on economy Introduction The negative impact of falling oil price on the economy is that it leads to the situation of economic recession on the economy. The significant decline in the oil price is due to the errors in the monetary policy that is implemented by the Central Bank which has led to the situation of monetary contraction resulting in the economic recession throughout the world. During the period of economic recession the activity of the world economy contracts and the demand for oil also decreases and as a result the price of oil falls significantly. The present fall in the oil price on the economy is not supported by economic growth contraction and this remarkable fall in the oil price has been experienced by the economy for the first time. The present decrease in the oil price on the economy is not due to the fall in demand but increase in supply of oil on the economy. The consumption of oil on the economy is directly related to the economic growth. The fall in the oil price has negative impact on the exporters of the world. The fall in the oil prices will result in the deficit budget of the government and this requires the increase in the taxes and cut in the government spending. The decrease in the oil prices will result in the situation of budget deficit on the economy and emergence of various social problems. The fall in the oil price leads to the situation of weak global demand of oil on the economy and it leads to the decrease in the investment and consumer spending and increase in the debt burden. Discussion Reason for fall in oil price on the economy The fall in the oil price has negatively affected the economy. The crash of oil price on the economy has an adverse affect on the global economy. The decrease in the oil prices were considered as favourable for the countries like US and Japan where the price of Gasoline was very low . On the contrary the decrease in the oil price has affected severely to the oil exporting countries like Russia and Venezuela since Venezuela may encounter unrest on the economy and increase in the debt obligation and the fall in the oil prices have adversely affected the oil rich countries like Saudi Arabia as they will face severe loss if the price of oil continued to remain low. Figure 1: Budgetary breakeven price (Sakir, 2014) And this fall in the oil price experienced by the economy in the year 2014 has resulted due to the fact that the price of oil has rouse significantly in the year 2000 and with the increase in the oil price many of the energy companies gained profit through the extraction of oil from the difficult oil drilling places .In U.S they adopted the technology of drilling horizontally in order to extract oil from the shale formations in Texas. This has resulted in the increase in the oil production. This increase in the oil production by US has started affecting the global price of oil on the economy. The reason behind affecting the global price on the economy is because in that period of time a situation of conflict was prevailing in the oil regions. There was civil war prevailing in Libya and Iraq was also facing constraints from ISIS. By the year 2014 the situation of conflict that was prevailing in the oil region has become normal and the countries like Canada and US continued with their production and the supply of oil have grown remarkably during these period. The demand for oil has suddenly fallen in Asia and Europe and the demand of oil have decreased in several countries of the world. The countries like Venezuela wanted and supported increasing the price of oil in order to cover its break even on the budgets and make payments for the government spending. On the contrary Saudi Arabia was of the opinion of decreasing the oil prices on the economy (Zhao, 2014). The fall in the oil prices has resulted from the increase in supply and not from the increase in demand. So with the continuous fall or decrease in the oil price the producers of US may find this business unprofitable and will leave out. The combination of fall in the demand more than that is expected along with the constant increase or rise in the supply of the oil prices has resulted in the decrease in the oil price from $115 per barrel to $80 per barrel in the year 2014. Negative Impact of fall in oil price on the economy The supply of oil was much higher than its demand which has resulted in the significant fall of oil price throughout the world. The fall of oil price happened in 2001 but it created a long term effect on world’s economy. Many large nations of the world export huge amount of oil to different countries. This is one of the important sources of income for those countries. The fall of global oil price created a major revenue shortfall of the countries which export oil. Countries like Saudi Arabia, Nigeria, and Venezuela etc earn a huge amount of money by producing and exporting oil. But the fall of oil price lowered the earning of these countries. As a result the economic growth and development of those countries got hampered. The economy of Russia also got negatively affected for the fall of oil price. This is because Russia is one of the big oil producing countries of the world. 70% of this countries income depends on the export of oil. But for the fall of oil price the currency of Russia became very weak for which its interest rate increase a lot. As a result the country faced a huge loss in its revenue generation with the fall of oil price. Interest rate of countries getting affected by the drop of global oil price create major problem in economic growth of the countries (Abeysinghe, 2001). High interest rate creates difficulties for the businesses to spend and borrow money. Another strong impact of the fall of oil price has created a rise of inflation level in many countries. Therefore the economic growth of the world is getting hampered by the constant rise of inflation level. Oil producing companies suffered a huge loss for the fall of oil price. For low demand of oil the companies were not been able to generate profit. As a result some of the oil producing companies where forced to shut down their business. For this reason many people became unemployed which reduced the economic growth of the countries. Still now the world economy is facing recession for the fall of oil price. The economic growth of major countries of the world has got hampered for low oil price. High inflation level has lowered their GDP growth. As a result the investment level of the countries have significantly fallen down which affects the business growth negatively. Exports of many companies have significantly dropped with the fall of oil price which lowered the income level of many countries. Therefore the fall of oil price flatters the world’s economic growth. For the fall of oil price low amount of revenue is generated from the export of oil. This has lowered the cash inflow of many countries. Moreover various nations of the world whose income mainly depend on oil are facing problems to repay their debts as their income level has fallen down significantly. For all of these reasons the world’s economy is getting negatively impacted by the fall of oil price (Jiménez-Rodríguez and Sánchez, 2005). Significant countries of the world are facing crisis for the fall of oil price and their crisis are also affecting the economic growth and development of other countries. Impact of fall in oil price for different section The price of oil has decreased more than 50% in the recent years. The fall or the decrease in the oil price has affected the economy severely and it has lead to the situation of reduction in the transportation and the business cost on the economy. The fall in the oil price has affected positively and negatively to different sections of people. The fall in price have positively affected the oil importers such as china, India, Japan, Western Europe and it has negatively affected the oil exporters such as Nigeria, Kuwait, Iraq and Venezuela (Dervis, 2015). The impact of fall in the oil price on the importers can be explained as the reduction in the oil price has benefitted the oil importing countries in reducing the cost of living. The decrease in the oil price has lead to the decrease in the cost of transport, lowering the inflation rate and also reducing the cost of living. The decrease in the oil price is considered as one of the most important reason behind decreasing the inflation rate in UK. With the constant wage rate, the decrease in the oil price has facilitated the consumers with more income for its spending. The fall in oil price has lead to reduction in the tax rate. The fall or the decrease in the oil price has resulted in the increase in the spending capacity of the consumers on various goods and services leading to the increase in GDP of the economy. The impact of the fall in the oil price can also be explained with the help of the diagram. Figure 2: economic impact of fall in oil prices. (Arnold, 2008) The fall in oil prices have reduced the inflation rate and increase in output on the economy. The above diagram reveals that the fall or the reduction in the oil price will shift the short run aggregate supply to the right side thus leading to the reduction of inflation rate and contributing towards the increase in GDP. On the contrary the fall in oil price have negative impact on the economy and the adverse affect of the fall in the oil price can be explained as the decrease or the fall in the oil price have negatively affected the exporters of oil since many of the oil exporting countries mainly depends on the tax revenue from the oil production to the government spending funding. The example of adverse affect of fall in oil price can be explained in reference to Russia which earns more than 70% of its tax revenues from oil and natural gas (Abel and Ben, 2005). Thus the decrease or the fall in the oil price has lead to the situation of deficit budget of the government and this will require cuts on the government spending and also result in the increase in the tax rate on the economy. The oil exporters mainly depends on the oil for meeting all its debt obligations, fulfilling its social spending etc and therefore the fall in the oil price will affect the revenue base of the oil exporting countries of the world. The fall in the oil price could result in the situation of increase in the social problems and increase in the budget deficit. The fall in the oil price has also adversely affected the European countries since it will lead to the situation of Deflation on the economy thus resulting in the increase of the macro economic problems. The fall in the oil price has reduced the rate of investment and increased the debt burden and it has also reduced the level of confidence of the consumers (Sexton, 2007). The most significant adverse affect of the fall in oil price on the economy is that it has reduced the profitability for utilization of alternative source of energy and the fall in the oil price would reduce the investment towards the alternative greenery form of energy such as the electric cars. Application of economic models The price of oil has fallen recently and the reason behind the negative fall in the oil price is due to the increase in the supply in the world market. The fall in the oil price has lead to the reduction in export on the economy. The impact of the fall in the oil price can be explained in accordance with the Balance of payment since the fall in the oil price and reducing the value of their imports and the rise in the oil price increases the value of the export leading to the situation of reduced trade surplus. The Aggregate demand can be applied in explaining the impact of the negatively fall in the oil price on the economy. The National income of the country or the economy is measured as National Income = Aggregate Demand – Aggregate Supply The above model is derived from the circular concept that is used or applied for determining the income and its affect on the economy as a whole. The circular flow of proceeding includes the new spending (C) and the income is represented as (Y). The spending and the income circulate continuously in the macro economy and this is considered as the circular flow. The aggregate demand consists of the spending on the goods(C), the spending done on the capital investment on the economy ( I), spending of the government (G) , export (X) and import (M). This can be derived by an equation Aggregate demand (Y) = C + I + G + (X – M) Y is considered as the aggregate demand for oil which has decreased with the fall in the oil price and the other factors have remained constant but the aggregate supply has increased. The aggregate supplies of the oil have increased more than it was expected which lead to the fall in the price of oil on the economy. The difference between the Aggregate demand and aggregate supply determines the national income of the economy. The decrease in the oil price is advantageous or preferable for the importers and it is unfavourable or constraint for the oil exporters. This statement can be explained with the help of the following aggregate demand curve. Figure 3: Aggregate Demand curve (Gottheil, 2013) From the above diagram it can be represented that the aggregate demand curve establishes the relationship of the AD and the price of the oil .From the above diagram it is taken into assumption that the aggregate demand curve will shift from the left towards the right and the reason of the shift of demand curve because all the variables of the aggregate demand except the import components are inversely associated with the price level. The downward movement of the aggregate demand in the oil price has lead to the situation of recession on the economy and the aggregate demand curve can become variable. Recession will affect all the factors such as consumption, spending of the government, investment and net export of the economy which will result in the slowdown of the GDP of the country and thereby affecting adversely and negatively the economic activity of the country. The fall in the price of oil will result in making the export less competitive as compared to the import. The sudden fall in the oil price on the economy have lead to the economic shocks due to the fluctuations in the employment, output and the national income on the economy. The fall in the oil price have lead to the reduction in the production making the economy unfeasible as a result the large producers will be able to sustain creating problem for the small producers. The fall in the oil price will decrease the extent of profit, generation of revenue and the cash flow generation on the economy. The fall in oil price has resulted in lowering the demand and decrease in the oil exports (McEachern, 2008). Steps taken to eradicate the problem The main reason behind the fall in the oil price is lack of balance or equilibrium between the supply and demand for oil in the market which is likely to prevail in the future period of time and therefore it has been advised that the demand for the production of oil is to be increased. The control in the oil price will provide better resistance of the economy .The aggregate demand of the oil is to be increased in such a way that it affects positively the growth of the economy and brings or develops stability in the price. The intention of the United States for manipulating and bringing drastic changes in the oil price is required to be restricted. Conclusion The fall in the oil price are more harmful for the oil exporting countries as compared to the oil importing countries since the revenue of this oil production countries are generated from exporting of oil to other countries therefore it would negatively and adversely affect the countries that depends on the oil revenues for fulfilling their debt obligations as well as meeting off their liabilities. The reduction in the oil price will adversely affect different countries in different ways. The fall in the oil price will positively affect the oil importing countries while it will negatively affect the oil exporting countries and in that case some industries will be benefitted out of it and some other countries will suffer severely. The countries like US and Canada may be adversely affected due to the decrease in the production and increase in the oil prices and will be positively and favourably affected with the increase in the oil price. The continuous fall in the oil price will make the economy infeasible. The decrease in the oil price on the economy will lead to the situation of inflation as well as recession on the economy. The main reason for the fall in the oil price is due to the oversupply of oil on the economy. The further fall in the oil price can lead to the situation of recession on the economy which will be very difficult to eradicate and control. The fall in oil price has also resulted due to the disequilibrium between the demand and the supply of oil. 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. Retrieved from : < http://www.globalpolicyjournal.com/blog/27/01/2015/oil-price-opportunity>. Gottheil, F. M., (2013). 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