Download The Oil Import Premium

The Oil Import Premium
-imported oil costs US society more than the
market price.
Two Main Components
• Demand Component: effect of changes in
import demand on the world price of oil
– Direct Cost: The last barrel demanded will increase the price
of all the previously demanded barrels.
– Indirect Cost: effect of rising oil prices on exchange rates,
capital formation, income distribution and factor productivity
• Disruption Component: the economic cost of
an interruption of imports
– Direct Costs: Increase in wealth transfer abroad, reduction of
domestic production of goods and services, reduction in total
output.
– Indirect Cost: Loss of aggregate income because non-oil
markets cannot adjust efficiently to the oil price shock.
Macroeconomic Costs of
Disruption
• Supply side
– Caused by rigid wages and prices
• Redistribution of Income
– Changes the composition of demand
Rigid Wages Cause Inefficiencies
in the Labor Market
• Disruption in the oil supply will cause oil prices to
rise- but wages may not decline in response.
– Causes: Long-term contracts, hiring/firing costs,
social pressures.
Why Should Wages decline?
• Wage of workers is the marginal productivity (MP) of labor.
• Decreased oil imports lowers the MP of labor.
– Because production function is Y(K,L), labor is a joint input with oil.
– With less oil, the marginal productivity of an extra unit of labor
declines, lowering the demand for labor.
• If nominal wages do not change in response to this decrease in
demand, firms will trim labor costs by reducing the level of
employment.
• Workers become involuntarily unemployed- people would be
willing to work for lower wages.
– Price of labor does not reflect the cost of unemployment
– Reduction in employment implies a reduction in output in addition to
that directly caused by an increase in the price of oil
Redistribution of Income
• On the demand side: an oil price shock will change
the level and composition of aggregate demand.
– Lag between receipts and expenditures will temporarily reduce
aggregate demand.
– This will also aggravate the adjustment problems on the supply
side.
• Income will shift from domestic oil consumers to
foreign producers (and domestic producers).
• Because of oil taxes, income will also shift to the
government.
– One solution would be to alter the timing of federal
expenditures and receipts, i.e., tax receipts could be
temporarily deferred.
Potential Solutions
• 1st Best: correct market inefficiencies
• 2nd Best: turn to the stimulus for the
problem- oil prices.
– Disruptional effect of income transfer to
foreigners is directly related to the quantity
of oil imports.
Questions/ Criticisms
• Tariff may not reduce the percentage of oil imported
from high-risk countries.
• Bathtub model suggests that it does not matter where
you import oil from- how to reconcile this?