Microeconomic

Introduction

This focuses on the recent increase in oil prices all over the world , when there is an increase in oil prices there is high possibility that this will increase the prices in the entire economy . According to MSNBC article available at HYPERLINK "http /www .msnbc .msn .com /id http /www .msnbc .msn .com /id / the price per barrel of crude oil rose to 128 dollars , this has a negative effect on an economy due to the dependency of oil in the production process either directly or indirectly . A similar crisis occurred

in the year 1973 to 1985

Effects of increasing oil prices on the economy

When oil prices rise the economy experiences an external shock , a shock can be disastrous to an economy because in most cases the occurrence is not usually anticipated and therefore the economy is nor prepared for the price change . Oil is widely used in every industry in an economy some countries import oil from oil producing countries , when the price of oil increase the oil importing country experiences a rise in the cost of imports , when import prices rise than the export value then there is an occurrence of unfavorable balance of trade leading to trade deficits

Trade deficits experienced by countries lead to increased debt problems especially to the developing countries that heavily depend on imported oil . The debt problems will be experienced due to the rise in the oil prices and this will lead to a decline in the performance of the global economy

A country that imports oil will also experience a rise in the prices of good and services in the entire economy , oil is used as an input in almost all the industries in the economy and when the price rises then the industry will transfer the cost burden to the consumer by increasing prices , when prices rise the economies of the world are likely to experience crises in that they will formulate policies to avoid the rise in price levels in the economy

From the Phillips theory of inflation and unemployment the cost of reducing inflation in an economy is unemployment and that the cost of reducing unemployment is inflation , for this reason therefore an economy that will aim at reducing inflation caused by oil prices will lead to increased levels of unemployment

Monetary policy makers will increase the interest rate to avoid inflation , interest rate is the opportunity cost of borrowing funds and when the opportunity cost rises less funds will be borrowed for investment purposes , this will lead to a decline in the investment levels in an economy and because investment provides employment then a decline in investment levels will lead to less employment

Unemployment caused by the increased oil prices will lead to a decline in an economies per capita income . This means that some individuals will not have income to spend and therefore the aggregate demand in the economy will decline

Fiscal policies are those policies that include government spending and taxation , when...