# 9. Oil prices

Table 9 presents the effect of a permanent 10 per cent increase in world market oil prices. A change in world oil prices affects also other countries and hence foreign markets and foreign prices will be affected. However, the experiment here does not take this into account.

Table 9. The effect of a permanent 10 per cent increase in world market oil prices

The increase in oil prices raises expenditure on energy imports, and the balance of payments deteriorate immediately. Nevertheless, energy exports also increase and offset the negative effect on the balance of payments. The public budget improves in the short run. Because higher oil prices mean higher taxable profits in the hydrocarbon-extracting industry.

The increase in energy price affects the general price level, and the accompanying fall in real income reduces consumption and the economic activity. In the medium run, the higher unemployment moderates wages and increases competitiveness, so that the period of contraction is followed by a period of expansion in employment and production.

The long-term effect on employment is zero similar to the previous experiments that all represent demand shocks. Thus, the increase in oil prices may represent a shock to the supply side of the international economy but it does not constitute a permanent supply shock to the employment. The long-term effect on GDP is negative partly due to the substitution effect of the permanent fall in the relative price of labor, and partly due to the permanent fall in private consumption, which triggers a fall in the content of indirect taxes in GDP. In general, the higher oil price works as a negative demand shock, but the higher public revenues can be used to increase e.g. private consumption.

Figure 9. The effect of a permanent 10 per cent increase in world market price of oil