How To deal with High Oil Prices

High oil prices is not the end of the world. In real terms, oil prices increased by more in the 1970s. This spike in oil prices encouraged a wave of innovation and changed consumer behaviour. The rise in oil prices helped to change the use of oil for creating heat energy. Rather than use oil powered electricity generation, countries switched to other forms of energy.

Now that oil prices are rising again, it is likely to see an increase demand for fuel efficient cars. Interestingly, the US is seeing a sharp fall in demand for SUVs which require high gas consumption.

For the consumer, there are many ways to save money on petrol consumption, for example, these top 10 ways to reduce spending on petrol

For oil companies the higher prices are incentives to look for new oil supplies and also try and increase general oil efficiency. British Petroleum have recently changed their tagline to BP Beyond Petroleum, suggesting they are looking into alternatives to oil.

Further Reading

• A World Without Oil - How the world can prosper without oil

Oil Price Futures

The price of oil has continued to relentlessly increase. However, a good question to ask is - how much is this due to economic fundamentals and how much is it due to speculation?

In a way the two issues are closely related. There is rising demand for oil, especially because of the breakneck rates of growth in China and South East Asia. This rise in demand is dwarfing the slower growth from Western economies.

Supply is not falling; but, it is struggling to keep up with the rise in demand.

However, because of the rising price of oil, it is encouraging people to buy oil futures, therefore, the price is being pushed higher by speculators who are banking on oil prices rising. Even though there are sound reasons for the price of oil to go up, it is quite possible prices will rise by more than they should do creating a speculative bubble

Prospects for Free Trade in the Global Economy

Free trade involves 2 countries having the ability to exchange goods and services without tariffs.

Advantages and Benefits of Free Trade.

1. Law of comparative advantage states that if countries specialise in producing goods where they have a lower opportunity cost then they will be a net gain to both the exporter and importing country. Consumers will benefit from lower prices and exporting firms will have more markets to sell to, creating jobs and output.

2. Increased trade will increase in competition. A firm like British Steel who used to have a domestic monopoly will now face competition from abroad. This increased competitiveness should provide incentives for domestic monopolies to cut costs and be more efficient.

3. Free trade enables economies of scale. Firms can specialise in producing goods and get various different economies of scale such as bulk buying and specialisation.

4. Countries can make use of raw materials. e.g. saudi arabia can export oil and import goods.

5. Look at how bad the common agricultural policy is.


However despite the advantages of free trade, politicians often highlight the disadvantages of free trade. IN particular these disadvantages are often focused on a small sector of the economy, but, this sector may be highly vocal and politically powerful leading to tariffs being maintained

Arguments Against Free Trade.

Some domestic firms will lose out and go out of business creating unemployment which may be hard to reduce.

Infant Industry Argument. This states that developing countries need protection to enable the industry to develop. In the beginning they will not have economies of scale, they may not have skilled labour. Protection enables them to get foothold and the hope is that they can reduce over time. This is a good argument for developing countries but not for developed countries. This is why people often say free trade is biased towards rich countries.

Diversification. Countries comparative advantage may lie in primary products. But, it is good to diversity to reduce risk of concentrating on one good.

Environment. Free trade enables countries to exploit weak environmental laws elsewhere.

Free trade has always been a contentious issue. It appears that many non economists remain unconvinced over its merits

Effect of Interest Rates on Savings, Mortgages and Economy

Higher interest rates would have the following effects

• Increased incentive to save and less consumption. However, people with savings will get more income from the higher returns, therefore their spending may increase.
  
• Borrowing more expensive, therefore, lower consumption and investment
• Increased mortgage payments leaving homeowners on variable mortgages with less disposable income leading to lower consumer spending. This will not affect people on fixed rate mortgages until the end of their period
  
• Appreciation in the exchange Rate because hot money flows cause increased demand for sterling. The appreciation will help reduce inflation and could worsen the current account deficit.

The overall effect is to slowdown economic growth, lower inflation but could cause a rise in unemployment

However,

• Higher rates may not reduce investment and consumption because they are optimistic and willing to pay higher rates.
• If interest rates increased around the world at the same time then there wouldn't be more hot money flows for the pound and the pound wouldn't appreciate.
• Depends on the situation of the economy. If the economy is at full capacity then lower AD may reduce inflation without causing lower economic growth.
• In the UK, people are sensitive to interest rates changes because many have variable mortgages which take a high % of their disposable income. Even a small change in interest rates can have a big impact on disposable income and spending which is 66% of Aggregate Demand.
• Higher interest rates may help improve the current account because higher interest rates will reduce consumer spending and therefore, reduce consumer spending on imports.
• However, higher interest rates will cause an appreciation in the exchange rate. An appreciation makes exports more expensive and therefore reduces exports

What determines the effectiveness of fiscal policy

Fiscal policy involves changing tax and government spending to influence Aggregate Demand. The aim of fiscal policy is to keep inflation low and maintain stable growth.

Recently, the US government cut income tax in an attempt to boost the economy. How effective will this be in stimulating the economy?

Factors determining the effectiveness of fiscal policy include:

Consumer Confidence. e.g. the government may cut income tax to boost consumer spending and increase growth. However, if confidence is very low then lower taxes may be insufficient to avoid recession. e.g. US is facing a recession and government have cut taxes but, with house prices falling this may not be effective in encouraging sufficient spending.

Size of the Multiplier.

If the multiplier is high then an increase in government spending to boost growth will have a powerful effect because the increase in AD will be bigger than initial injection into the economy; there is a knock on effect.

Good Information? How accurate are the economic forecasts? People need to be able to predict future economic trends. Expansionary fiscal policy is needed if the economy is heading towards a recession. Therefore, fiscal policy requires good information about the future prospects of the economy.

Crowding Out - Increased government spending or cuts in taxes may not increase aggregate demand because government spending will lead to lower private sector spending.

More on fiscal policy