Discuss how rising oil price might affect the macroeconomic performance of an economy (25 marks)

In economies, oil is a highly desired resource that plays a key role in the production of goods and services and in the provision of energy, meaning that even small fluctuations in its price can lead to supply side shocks for nations as well as lower demand for imports as a component of aggregate demand. A supply side shock is a shock that will shift the Aggregate supply curve and in the case of oil will be a negative shock because it will increase costs for an economy, as they are dependent on it.

Oil is, for a large number of products and services, fundamental to their production, be it in the manufacturing of the good itself or the energy needed to perform tasks in transportation, heating storage etc This therefore follows that oil is a major cost of production for goods and on a macro level effects Aggregate supply shifting it to the left. In indicated by the shift from AS1 to AS2 in the graph. The magnitude of the shift will be dependent on any stabilisers the economy has in place to dampen the effect of the shock such as fast acting fiscal responses, like reducing the tax on oil but it is undoubtedly true that these will not cushion the shock completely. A shift in, AS will have two important effects: an increase in inflation due to the new raised price level and an increase in unemployment. It could have been argued that in the short run, the economy would hold true to the Philips curve and so this rise in the level of inflation would decrease unemployment but this is not the case. As Oil is a cost of production, it means that producers will have higher costs and so will inevitably have to lay workers off. This will add to the unemployment level within an economy as businesses can afford few numbers of workers and will put further demand on any welfare