"Oil Prices Slide Back to $60": Impact of Supply and Demand in Prices

            The article "Oil Prices Slide Back to $60" reflects how classic economic theory regarding supply and demand impacts prices. According to the article, prices fell because supply increased more than demand. Production increased because the industry is now recovering after Hurricane Katrina and because of a resolution to a union strike that had cut production by half for a major oil company, Shell. Increase in demand has been held in check by a mild start to the winter season and by the use of cheaper substitutes for oil even though the U.S. experienced stronger-than-expected retail sales, an event that generally increases the demand for oil. .

             This slight decline in oil prices is good news because if oil prices had risen because of a shortfall in supply, Gross Domestic Product would surely have fallen. This is true because the higher oil prices serve as a tax on consumers, leaving them less money to spend on other goods. Thus, an increase in oil prices causes the short run aggregate supply to shift inward, putting upward pressure on the price level until demand can adjust. Any pickup in consumption or shortfall in production for a commodity as price inelastic in the short run as oil will be immediately reflected in a rise in oil prices. A sharp increase in oil prices can cause inflation, particularly painful for countries such as the United States that imports lots of oil and has many industries that use oil in production. And, inflation usually leads to an increase in interest rates. Although oil prices are still relatively high compared to prices over the past few years, at least they appear to reflect healthy economic growth as indicated by the article "Oil Prices Slide Back to $60". .

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