18th July 2015.
Table of Contents
Law of Demand…………………………………………………………………….3
Demand and Aggregate Demand…………………………………………………..4
Factors of Aggregate Demand……………………………………………………..6
The United Kingdom, just like many other importing countries, have had some sort of renaissance ever since the beginning of the oil slump. The country has had its own benefits as can be noted from the changes in its economy and its people. This paper is going to analyze the effect of the present oil slump and how the oil prices affect the aggregate demand in the United Kingdom.
Law of Demand
The United Kingdom has a market that is generally flexible and susceptible to the laws of demand and supply.The demand and supply in the U.K economy is somewhat often as a result of the market shocks created by the fluctuation in oil prices. of supply and demand, through which the concept of aggregate demand can be clearly fathomed(Millard & Shakir,2003). Naturally, there are usually those sets of things that human beings want, and the entities from which they want those things from. The U.K economy has been susceptible to the shocks.
These entities include things such as natural resources, capital and labor. However, from an economic point of view, these two entities can never be at equilibrium. This is just to mean that one of the entities must be in little amounts, so as to make the relationship between the two quite mutual(Mankiw,2012) .When this is translated into production and consumption of goods and services within the society, price is introduced. Normally, the prices are usually set or dictated in a given society or market, by the producer if there is no competition. However, if there is competition, then the producers have little power to do so, and therefore, these prices are set and controlled by the market.
However, when the market or the consumer sets the price, then it will most likely not favor the producer. The converse is true as well. Low prices, as favored by the consumers of the products and services, have the opposite effect of demoralizing the producer, and thereby having a negative effect on production. High prices on the other hand, have a really encouraging impact on the producers, thereby encouraging the production of the goods and services, while demoralizing the consumption of the same, by the consumers. As a result, for both sides to have some sort of balance, then the forces of supply and demand must match. This is essentially the law of demand and supply, and it well goes into the analysis of the crude oil market in the present business environment. The United Kingdom in this case,is the consumer, and has a greater say in the law of demand and supply. (Mankiw, 2012).
Demand and Aggregate Demand
As highlighted in the introduction, this paper is to focus on the United Kingdom,an oil importing country , hence aggregate demand. Since this paper is specifically going to delve into analysis of aggregate demand, then a brief preview of demand is mandatory. Demand simply means the set of aspects that altogether add up to make a consumer buy a certain product at a given time. Such aspects include desirability as well as the price of the good or service. When a good is very costly, then chances are high that the consumer won’t buy it, or will buy it in very limited supply. On the other hand, when the price is low or moderate, then there is a high likelihood that the consumer will buy more of it. This essentially is what is known as the law of demand; an inverse relation between the price, and purchase.
The current situation in the oil industry has borne exactly similar effects as the ones identified here. It is one of the most flexible products when it comes to the operations of the law of demand as discussed. The supply of oil in the United Kingdom plays a huge role in the aggregate demand of the country. Aggregate demand is the cumulative sum of the demand of a certain product or service within a given economy. In this case, it is the cumulative sum of all the oil demand within a given country at a given period of time. It possesses a huge similarity to the law of demand, only differing due to the main players when it comes to aggregate demand. These are; the expenditure per household, the government spending, the net investment in the U.K, and the imports.
The slump in oil prices will have a number of effects on the aggregate demand. Now, aggregate demand, as earlier mentioned, is related to the law of demand. This is to mean that it is inversely proportional to price and subsequently, has an overall effect on expenditure. Therefore, the decrease in the prices of crude oil in the international market will have a subsequent increase in expenditure by the importing nations as a result of a new found financial freedom and flexibility. This can be explained by a number of effects; the interest rate, the wealth and the international effects (Arnold, 2010).By coincidence, the initial economic status of the U.K ensures that these aspects are well impacted with the prices.
Factors of Aggregate Demand
The wealth effect states that the when the price of a product rises, there is a subsequent feeling of loss from the consumers within the U.K, which scares them from spending and consuming more. This means that, with the fall in the prices of crude oil, countries importing the product,in this case the U.K, will have consumers who are confident of spending since the prices are friendly .Therefore, considering that household consumption is a factor of aggregate demand, there will be a subsequent increase in expenditure with the fall in the crude oil prices, and hence increasing the quantity of the crude oil demanded (Tucker, 2012).
The interest rate effect opines that a fall in the prices of a good or a product, in this case crude oil, results to a fall in the interest rates which has an overall effect on lending. Therefore, people within the U.K will have more money because they will have ease of taking loans (World Bank, 2015). Subsequently, investments will increase since people will be more willing to put money into development projects. It should be noted that investments are one is one of the building blocks of aggregate demand. As a result, the fall in oil prices might have a subsequent increase in the investments within the U.K, which will help in its economic development. (Poghosyan & Hesse, 2009).
The international effect states that, as the prices of the product rise, it may become unaffordable for the international market. Hence the total amount of exports will most likely fall. This will also have a resultant effect of having an increased amount of imports since the product at home will seem more costly than the one from outside. By looking at this present case of the fall in oil prices, it means that the oil becomes more affordable on the international markets,since the U.K. market will want more of it (Arnold, 2010).
With an increased aggregate demand, there is going to be a decrease in the energy costs, such as oil related transport costs .A reduction in transport costs is accompanied by reduced inflation of an economy. For example, since the beginning of the oil slump, the United Kingdom has had a reduction of inflation to around 1.6 %( Pettinger, 2015).This is just one example of how inflation will reduce .
In conclusion, the fall in the international oil prices has been a welcome boost for oil importers in general, specifically the United Kingdom as one of the major oil importing countries. This is as a result of the aggregate demand concept, which has been analyzed to have impacts on households’ expenditure, national investment, governmental expenditure and imports. Benefits of the oil prices falling include decreased rates of inflation and expansion of its economy.
Arnold, R. A. (2010). Economics. Australia: South-Western Cengage Learning.
Czech, B. (2013). Supply shock: Economic growth at the crossroads and the steady state solution. Gabriola Island, BC: New Society Publishers.
Mankiw, N. G. (2012). Principles of macroeconomics. Mason, OH: South-Western Cengage Learning.
Morgan, P. J. R. (2012). Euro crisis: Aggregate demand control is European single currency weakness: a critique of the current European economic governance system, with practical solutions. England: Morganist Economics.
Pettinger, T. (2015). UK Inflation Rate and Graphs. Retrieved from http://www.economicshelp.org/blog/5720/economics/inflation-stats-and-graphs/
Poghosyan, T., & Hesse, H. (2009). Oil Prices and Bank Profitability: Evidence from Major Oil-Exporting Countries in the Middle East and North Africa. Washington, DC: International monetary fund (IMF.
Tucker, I. B. (2011). Macroeconomics for today. Mason, OH: South-Western Cengage Learning.
World Bank. (2015). Global economic prospects, January 2015: Having fiscal space and using it.
Millard,S.,Shakir,T.(2013). Oil shocks and the UK economy: The changing nature of shocks and
impact over time. Working Paper No. 476.