QUESTION

You are to select a newspaper/magazine/web article for economic analysis. The article must relate to one or more of the topics (chapters) covered in the lecture program. The article must also have been written after 1st February, 2012. You are to apply your economic theory to explain and analyse the newspaper/media article. Refer to the ‘An Inside Look’ section at the end of each chapter in the textbook for examples. The assignment should be approximately 1400-1500 words in length and include well labelled diagrams. A copy of the article showing date and source is to be included with the analysis. Complete the assignment cover sheet and submit with your assignment. It is also very important to discuss the choice of topic/article with your tutor well before the submission date.

I would suggest that you present your assignment as a report – include an introduction, economic concepts /theories to be applied, analysis, conclusion and references. Visit the blackboard site for notes on preparing the assignment. The CBS Communication Skills Centre conducts workshops on essay writing and referencing and you can always check with your tutor about planning and preparing your assignment. The assignment is worth 20% – 14 marks will be allocated for content and analysis (appropriate choice of article, relevant concepts and depth of coverage, sound application of theory, logical structure) and 6 marks will be allocated for professional skills (presentation, correct written expression, correct grammar and spelling, referencing).

An important part of assignment writing is to correctly reference the sources of information that you have used.

Correctly referencing your work will help to avoid plagiarism. Plagiarism means presenting the work or property

of another person as one’s own, without appropriate acknowledgement or referencing (the copying of other

people’s work and/or ideas). Plagiarism is a form of cheating. The penalty for plagiarism is a mark of zero and

possible expulsion from the unit and/or course of study.

Your assignment will be automatically checked for plagiarism by turnitin – you must submit your assignment

electronically via blackboard (see under Assessment).

SOLUTION

Contents

1. Introduction. 1

2. Impact of the Rise in the Crude Oil Prices. 1

2.1 Global Financial Crisis and its Impact on the US Economy. 1

2.2 Rise of the Crude oil and its Impact 3

2.2.1 Contraction of Aggregate Demand. 3

2.2.2 Stagflation. 5

3. Conclusion. 6

4. References. 6

1. Introduction

The US economy has recently experienced a sharp jump in the gas prices has driven the consumer price index upwards. This is the sharpest rise in the consumer price index in the past ten months forcing the index to increase by almost 0.4% and the gas prices to rise by 6% .The sharp increase in the crude oil prices eventually have an impact on the US economy already recovering from the impact on the Global Financial crisis. The paper examines the impact of the rising crude oil prices on the American economy and tries to explain the economics of the rise by supporting it with relevant economic theory.

2. Impact of the Rise in the Crude Oil Prices

2.1 Global Financial Crisis and its Impact on the US Economy

The recent crude oil price is likely to affect the US economy in more than many ways, especially with a sluggish economic recovery after the impact of the Global Financial Crisis. The sharp increase in the crude oil prices may further push the economy on the edge. From the year 2007-2009 the US economy has experienced severe economic contraction. Originated in 2007 the ‘Credit Crunch’ has had an impact on global financial as well as property markets this has led to the collapse of the international money markets globally. The decease of the subprime mortgage market in the US was the cause of the crisis. However the effects of the crisis were not apparent immediately but when the Bank of England identified the same problem originating in the English real estate market, the global impact of the situation had begun to be realised. Financial analysts have played an important role in the globalization of money and the property markets. Though the new methods of finance resulted in providing liquidity to investors on the other hand exposed the investor to a high degree of global risk. The collapse of the US residential market has resulted in creation of a global balance sheet problem. A$900 billion (out of a $9 trillion in mortgage debt) is in the sub-prime paper in global balance sheets of banks, investment houses, hedge funds and mutual funds.

(Adair et al, 2009,  1 )

Studies have suggested that the US economy was on the road to recovery from 2009 onwards. The real GDP has been showing a gradual increase since then which has eventually had a positive impact on the growth outlook of the US economy. However, there is large scale macro-economic concerns for the US economy which remain a priority, which implies reducing the levels of unemployment, returning to normal levels of output and growth and well as addressing the growing debt burden of the US economy.  Many analysts argue that the US economy is following a typical post-recession business cycle (Elwell ,2011, 1-5 )

Figure 1: Representation of Business Cycle in AD/AS Analysis (Source: hmc.edu – accessed on 14/05/2012,  7 )

Figure above shows then equilibrium points of the AD/ AS curves, but the AD and the AS curves are not shown. The aggregate demand is generally more volatile than aggregate supply. Movement of the  equilibrium from left to right represents the economic expansion supported by the expansion the real GDP In comparison the recession reflects an opposite movement . An upward movement is an indicator of rising inflation and increased inflationary pressures on the economy. The US economy can said to be in a post recessionary business cycle stage accompanied with marginally rising GDP and increased inflationary pressures on the economy. The pace of the economic recovery has relatively slow owned to decline in the private spending and investment which further leads to contraction of the Aggregate demand. A further stimulus cannot also be given to the US economy as it would eventually add to the debt burden of the government, thus leading to the creation of further pressures on the fiscal and the monitory systems of the economy. The increase in the long term debt will lead to increasing budget deficits of the government which would eventually lead to the reduction in the savings of the economy hence forth further reducing economic growth. Therefore the sluggish expectations of the US economy would continue for over a long period of time and hence eventually, leading to lower economic growth rates in the future (Elwell ,2011 , 1-15).

When the consumers in an economy experience a high debt – income ratio it leads to sluggish expectations and eventually contraction of the Aggregate demand in the economy.

Thus, the financial crisis has already had an impact on contracting the US economy as well as the aggregate demand in the US economy.

2.2 Rise of the Crude oil and its Impact

2.2.1 Contraction of Aggregate Demand

The sharp rise in the crude oil prices has come when the US economy is trying to recover from the severe recession it experienced in 2007-2009. The recovery though has been by far sluggish, but the rise in the crude oil prices can have a detrimental effect on the road to recovery for the US economy. The US economy has recently experienced a sharp jump in the gas prices has driven the consumer price index upwards. This is the sharpest rise in the consumer price index in the past ten months forcing the index to increase by almost 0.4% and the gas prices to rise by 6%. Over the past year the consumer prices have increased by over 2.9%, whereas the core prices have increased by 2.2%. The rise in the fuel prices has not had an impact on the prices on food products although has resulted in sharp increases in the commodity prices (cbsnews.com – accessed on 14/05/2012, Pp. 1 ).

A senior economist Mr Sam Bullard firmly believed that even if the gasoline prices in the US increased to $4 a gallon it would still not be able to push the American economy into recession but rather impact the road to recovery for the economy. The rise in the price is expected to eat the benefits in the form of payroll tax cut offered during the recession which was aimed at providing $1000 benefit to the households. The rise in the gasoline prices acts as a threat to both inflation and growth. The rise in prices serves like a tax which would already affect the already sluggish growth in income and demand experienced in the US economy (www.reuters.com – accessed on 14/05/2012, Pp.1 ).

When the consumers in an economy experience a high debt – income ratio it leads to sluggish expectations and eventually contraction of the Aggregate demand in the economy. The figure below represents the impact of the high income debt ratio on the Aggregate demand.

Figure 2: The contraction the Aggregate Demand owning to high Debt- Income Ratio (Emc.edu – accessed 14/05/2012, Pp 10).

The economy is faced with low income expectations and as well as increased debt burden. The incomes in this case are not rising as fast in comparison to the debt burden faced by the consumers in the economy. The consumers thus experiencing a high debt burden have to cut back on their spending, leading to the leftward shift of the aggregate demand curve form AD1 to AD2 to AD3, depicting that the economy is slipping in to recession with contracting demand and the movement of the equilibrium leftward from a to b to c (Emc.edu- accessed on 14/05/2012, Pp. 9-10).

The rise in the crude oil prices to a recent record of $110, can lead to a contraction of the economy further. Further since the US economy was already in recession it can also push the economy in a situation of stagflation (bbcnews.co.uk – accessed on 14/05/2012, Pp 1 )

2.2.2 Stagflation

Stagflation can be described as a combination of inflation accompanied with recession. It is the worst possible cycle that an economy can experience. The US economy when exposed to the inflationary pressures and declining aggregate demand and a sluggish economic growth, which can push the economy back into recession, can be faced with a Stagflation like situation. Stagflation is caused by rising costs usually of the supply side factors, in this case the price of gasoline have been experiencing an upward trend owning to the global rise in the crude oil prices.

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