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Global oil prices fell from a 2008 peak of $147 a barrel to $27 in 2016 - Edexcel - A-Level Economics A - Question 8 - 2017 - Paper 2
Question 8
Global oil prices fell from a 2008 peak of $147 a barrel to $27 in 2016. Evaluate the likely macroeconomic consequences of a significant fall in global oil prices.
Worked Solution & Example Answer:Global oil prices fell from a 2008 peak of $147 a barrel to $27 in 2016 - Edexcel - A-Level Economics A - Question 8 - 2017 - Paper 2
Step 1
Possible macroeconomic consequences
Answer
The significant drop in oil prices can have several macroeconomic consequences:
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Increase in Overall Economic Activity: Lower oil prices reduce production costs for businesses, particularly those heavily reliant on oil inputs. This can lead to an increase in real GDP as firms enjoy reduced input costs, potentially contributing to growth in real GDP by 0.1 to 0.5 percentage points.
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Consumer Benefits: Consumers may benefit from lower costs of goods and services, as cheaper oil often leads to lower transportation and production costs. This increases disposable income, which can boost overall consumption.
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Impact on Oil Producers: On the other hand, oil-producing nations and companies may face significant challenges due to falling oil revenues. This could lead to a collapse in employment levels in these sectors, reduced tax revenues for governments, and overall economic instability in oil-dependent economies.
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Effects on Other Sectors: Industries such as tourism and transportation that are energy-intensive may see a positive impact, as lower oil prices help reduce their operating costs.
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Financial Market Reactions: The sharp decline in oil prices may lead to volatility in financial markets. Companies in the oil sector may experience stock price collapses, which can affect overall investor confidence and lead to broader market declines.
Step 2
Evaluation points
Answer
When evaluating the consequences, several important factors must be considered:
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Long-Term Sustainability: The long-term effects on oil-producing nations can lead to significant economic challenges. Countries like Venezuela and Russia, heavily reliant on oil revenues, may see economic turmoil and social instability.
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Adjustment in Other Economies: Other sectors may struggle with their own adjustments. For example, nations that depend on oil exports for economic stability may require time to adapt to lower revenues and diversify their economies, leading to prolonged economic hardships.
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Geopolitical Stability: Fluctuating oil prices can affect geopolitical relationships, as nations reassess their foreign policy and economic dependencies on oil imports and exports.
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Consumer Behavior Changes: While lower oil prices can increase disposable income, prolonged low prices might encourage increased consumption and higher demand, leading to potential inflationary pressures once the economy adjusts.
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Investment in Technology: A shift toward investing in alternative energy sources may be prompted as oil becomes less profitable, potentially spurring innovation but also leading to job losses in traditional energy sectors.