South-Western College Publishing - Economics  

Pumped Up Over Low Oil Prices
Subject Aggregate Supply, Aggregate Demand
Topic Output, Income, and the Price Level
Key Words Gross Domestic Product, Aggregate Demand, Aggregate Supply
News Story Asia’s economic problems are benefiting U.S. consumers because of declines in oil and gasoline prices. Oil prices have fallen from about $22 a barrel in October to about $12 a barrel. Lower oil prices have pushed gasoline prices, adjusted for inflation, to record low levels. According to the Potomac Chapter of the American Automobile Association, the average price per gallon of self-serve gasoline was $1.11 compared with $1.22 at the same time last year.

Asia’s economic weakness has reduced its demand for oil. OPEC countries tried to prevent prices from falling by agreeing to cutbacks in production; however, some oil-producing countries have not lived up to the agreement, and because the agreed-upon cuts were small to begin with, oil prices have fallen. Many oil industry analysts expect crude oil prices to fall to $14 to $15 a barrel this year from last year’s average price of $20.60.

Lower oil prices benefit the U.S. economy in many areas. A 10 percent drop in the price of oil is estimated to add .2 percent to U.S. economic growth. Besides transportation, iron and steel, aluminum, chemicals, glass and cement industries all benefit from lowered oil prices. Decreases in business costs help reduce inflationary pressures, helping to keep interest rates from rising.

The drop in oil prices does not benefit everyone. The U.S. produces about half of its oil consumption. A drop in oil prices hurts domestic producers, lowering revenues and prices.

Although it is better for the U.S. to have Asia economically strong, Asia’s financial weakness provides some offsetting benefits to the predicted drain on the U.S. economy due to the decline in U.S. exports.
(Updated August 12, 1998)

Questions
  1. Draw an aggregate supply/ aggregate demand diagram depicting an economy at full-employment macroeconomic equilibrium.
  2. Suppose that export demand were to decrease. Illustrate the impact of reduced exports on the real GDP and price level for this economy.
  3. What is the affect of a decrease in oil prices on the short-run aggregate supply curve?
  4. Illustrate the impact of the decrease in oil prices on real GDP and the price level.
Source Martha M. Hamilton, “Asia’s Troubles Helping to Keep Oil Prices Low in U.S.,” The Washington Post, June 19, 1998

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