It is important to understand the theoretical framework of our question regarding the link between oil prices and GDP. An oil price shock can be transmitted into the macro-economy via various channels. A positive oil shock will increase production costs and hence restrict output as it will require costly structural changes to production processes. Furthermore, higher oil prices lead to higher inflation which pushes an economy into contractionary monetary policy further reducing GDP. Additionally, due to countless possible exogenous supply shocks, oil prices are subject to uncertainty at any point in time. When prices are stable, economic agents tend to overlook the permanent underlying uncertainty, when making economic decisions. However, in an environment of already volatile prices, which we are cu
ently experiencing, economic agents are more likely to take future price uncertainty into account when making investment decisions. Overall, oil price volatility typically results in an increase of economic uncertainty and the long- run equili
ium relationship between oil prices and GDP will be tested through an Engle-granger co-integration test.
The impacts of exogenous shocks to world crude oil prices on Renewable energy consumption can be explained using the concept of substitution effect of a price change. AS seen in the graph, prior to the rise in oil prices, the optimum level of RE consumption takes place at point A where the Isoquant is tangent to the slope of the budget constraint. The slope of this constraint is given by the relative price ratio of renewable energy resources and crude oil. If the global oil prices rise, while the domestic price of RE is assumed to stay level, The relative price ratio would decline resulting in the slope of the budget constraint being flatter. Under these circumstances, the consumption of RE can be expected to rise while oil consumption is likely to decline. As such, the substitute effect can be seen as a rise in world oil prices can lead to an increased level of RE consumption by decreasing oil consumption. This will be tested through a regression analysis of OECD member countries. We assume that only the fossil fuel element of a country’s energy portfolio is directly exposed to the global commodity market price volatility, and thus it is possible to reduce the overall portfolio volatility by increasing the share of renewable energy which should have a positive effect on the countries net GDP.
ECON REPORT GUIDE
QUESTION 1
It is important to understand the theoretical framework of our question regarding the link between oil prices and GDP. An oil price shock can be transmitted into the macro-economy via various channels. A positive oil shock will increase production costs and hence restrict output as it will require costly structural changes to production processes. Furthermore, higher oil prices lead to higher inflation which pushes an economy into contractionary monetary policy further reducing GDP. Additionally, due to countless possible exogenous supply shocks, oil prices are subject to uncertainty at any point in time. When prices are stable, economic agents tend to overlook the permanent underlying uncertainty, when making economic decisions. However, in an environment of already volatile prices, which we are cu
ently experiencing, economic agents are more likely to take future price uncertainty into account when making investment decisions.
QUESTION 2
The impacts of exogenous shocks to world crude oil prices on Renewable energy consumption can be explained using the concept of substitution effect of a price change. AS seen in the graph, prior to the rise in oil prices, the optimum level of RE consumption takes place at point A where the Isoquant is tangent to the slope of the budget constraint. The slope of this constraint is given by the relative price ratio of renewable energy resources and crude oil. If the global oil prices rise, while the domestic price of RE is assumed to stay level, The relative price ratio would decline resulting in the slope of the budget constraint being flatter. Under these circumstances, the consumption of RE can be expected to rise while oil consumption is likely to decline. As such, the substitute effect can be seen as a rise in world oil prices can lead to an increased level of RE consumption by decreasing oil consumption.
ECON REPORT RELATED ECO THEORY
Question 1 - Related Economic theory/theoretical model which discusses and analyses the relationship between Oil price volatility and GDP. The relationship should include the impacts of oil price shocks on GDP. Include economic models that will help support this theory.
Question 2 - Related Economic theory/theoretical model which discusses and analyses how Renewable energy can act as a hedge/substitute against oil consumption. The use of Isoquants would be ideal.