Oil is deemed to be the most traded commodity in the world, and as a result, it is not a surprise as to why consumers around the world are sensitive to fluctuations in its prices.
Economy experts believe that just like any other commodity, oil prices often escalate due to increased demand which supersedes that of the quantity produced and supplied to the market, and this is majorly attributed to increased industrialization and urbanization around the world.
As the proverb says: One man’s meat is another man’s poison, news about escalating oil prices elicits mixed reactions around the world. The OPEC (Oil Producing and Exporting Countries) will welcome such news with open arms since that will imply improved balance of payments.
Their counterparts (the importers) on the other hand will see this as a catastrophe to their economy since it will affect the economic sectors which rely primarily on oil to thrive. This article sheds some light on three effects of increased oil prices on the economy.
Increased oil prices is one of the major contributors to increased inflation. This is manifested in the manufacturing, processing as well as in the transportation of finished products to the market.
This therefore means that production cost has a positive correlation with oil prices. When oil prices skyrocket, it implies that firms will have to incur extra costs so as to make their commodities available to consumers.
Firms always aim at maximizing profits or at least maintain the profit margins, and for that to be a reality it means that firms have to increase prices of their products. When this persists for a long period of time it brings about inflation which is attributed to increased production costs (cost-push inflation).
- Lower Living Standards of Consumers.
This is as a result of firms attaching higher prices to their commodities in order to maintain their profit margins as well as their competitive advantage.
This therefore means that consumers have to dig deeper into their pockets in order to afford the same oil and oil products they were purchasing before. Some people may not be in a position to afford the same products which they could buy with ease before. This therefore means that the welfare of many will deteriorate owing to increased oil prices.
- Firms and Consumers Switch to Alternatives.
This will however occur in the long run. When oil prices increase persistently over a long period of time firms will reduce their dependence on oil and instead shift gears to its substitutes.
Some of the oil substitutes used in industries include ethanol, solar power, nuclear power among others. Consumers on the other hand use oil majorly for domestic purposes like cooking.
Some of the products which can be used in place of oil include cornstarch, skimmed milk, applesauce among others.
In a nut shell, oil is very vital for any growing economy and as a result, the consequences of fluctuations of its prices cannot be overlooked.