Oil is a major component in the production of energy, which runs industry, and t

Question

Oil is a major component in the production of energy, which runs industry, and thus the price of oil strongly impacts the costs of producing most goods. And, of course, the price of gasoline strongly depends on the price of oil. In 2013 the average household in the US spent $2,912 on gasoline, which was just under 4% of average income before taxes and, except for 2008, was the highest percentage spent on gasoline in nearly three decades. Yet when the price of oil fell sharply in 2015, it seemed like the stock market responded negatively, and it too fell. Ignoring whether there is a statistical correlation between the oil price and the stock market, discuss what type of relationship economic analysis would argue should exist between the price of oil and equilibrium prices and quantities of other goods, and thus of the overall economy. HINT: The price of oil can drop from two causes, and increase in supply or a decrease in demand.

Explanation / Answer

There exist a positive relationship between the price of oil and equilibrium prices and quantities of other goods, and thus of the overall economy.

As the price of oil decreases due to the decrease in the supply , the price of other goods also decreases and hence the equilibrium quantity demanded increases.

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