Question

What is the price response rate (elasticity) before and after the recent Economic/financial crisis? Interpret these response rates. What do they tell OPEC?

Answer 1

While an increase in GDP growth and economic activity, in general, leads to increase in energy demand. The viewpoint that oil price spurts have a negative impact on the economies is based on the close correlation between oil price hike and economic slumps. This relationship was experienced in 2000, 2004 and 2008 respectively. Price elasticity of demand is always thought as negative.i.e. demand falls by a certain percentage for a certain percentage price rise of some factor input, in this case, is oil. Conventional economic reasoning embodied in the idea of price elasticity of demand .i.e. large oil price rises will necessarily cut oil demand and reduce economic growth. All things being equal, an oil price increase should be considered positive in oil exporting countries and negative in oil importing countries, while the situation reverses when oil prices decline.

An oil price increase leads to transfer of income from importing to exporting countries via a shift in the terms of trade. The global demand impact would rely on the amount of the extra revenue accruing to oil exporters is re-spent in the short term. The boost to economic growth in oil exporting countries provided by greater oil prices in the past has always been smaller than the loss of economic growth in importing countries such that the net effect has always been negative.