The Impact of OPEC Oil Embargo on US Economy

This assignment discusses the impact of OPEC's oil embargo on the US economy. In October 1973, OPEC member countries imposed an embargo on oil exports to the US, leading to a quadrupling of oil prices within six months. The increased oil prices resulted in a deep global recession and led to a shift in demand towards small cars and compact trucks. As oil prices fell by over 50% after the embargo was lifted, revenue decreased for energy-intensive industries and led to a rightward shift in the aggregate supply curve.

Running head: MACROECONOMICS
MACROECONOMICS
Name of the Student
Name of the University
Author note

1
MACROECONOMICS
Question 1a
Quantitative easing is required primarily for the purpose of ensuring a steady growth rate
in the economy. The Central banks and government of any economy want a safe growth rate of
their economies. They do not want it to increase which leads to inflation or make it too low
which could lead to stagnation. They increase or decrease the interest rates to control growth
rates. Low rates increase demand whereas high rates propel savings. Nevertheless, when there is
zero growth rate, Central bank uses the technique of pumping money into the economy and this
procedure is known as Quantitative easing.
Question 1b
Britain, the USA, Japan, European Monetary Union had embarked on it earlier than
Australia because of some promising signs. In the UK and the Euro zone, after the global
recessionary trends, inflation rate had come down to zero which had propelled these nations to
go the quantitative easing. It was their last resort as they have ran out of options after recessions.
Australian economy was in a relatively better condition after 2008, and it has at least 2.5
percentage points of rate cuts before going 1 or 0. This has prevented to use QE as a last resort.
Question 1c
One of the greatest risks of QE is the risk of excessive inflation, which might happen
because of pumping of money in the economy. The quantity equation of Irving Fisher describes
the relationship between money stock and aggregate expenditure. The equation is MV=PY. On
the right hand side, the price and the GDP represent the total spending and on the left hand side,

2
MACROECONOMICS
M represents the monetary value and V represents the velocity of the monetary measure. There is
a risk of increase in the inflation rate because of QE in the long run which is reflected in the
equation. When money is pumped in, the velocity of monetary measure increases and the
spending (PY) consequently increases and when this continues, the inflation rate rises to a very
high level.
Question 2
Assets in $ million Liabilities in $ million
Reserves 300 Deposits 600
Loans 200 Debt 200
Cash held in overseas bank 100 Capital (owner's Equity) 100
Securities 300
Total 900 900
Reserve Ratio: Reserves/Deposits= 300/600=1:2
Money multiplier :1/Reserve ratio=1/1:2=2
leverage ratio: Total Debt/Total Equity=200/100=2
New reserve ratio= 300/500=3:5
New leverage ratio: 250/100=2.5
Question 2a
The Reserve ratio of WBB has been calculated by dividing the bank’s Reserves and deposits. It
is a quantitative credit control method and is used by banks to regulate the flow of money in the
economy. WBB’s reserve ratio stands at 1:2 which shows, that for every two rupee deposit, the
bank has to maintain a rupee as reserve.

3
MACROECONOMICS
Question 2b
The implied money multiplier also is referred as the credit multiplier. It is a measure of
the change in the reserves maintained by the banks with the changes in the overall money supply
in the economy. WBB’s money implied multiplier has been calculated by dividing 1 with the
reserve ratio calculated prior. It actually shows the amount of money WBB creates with each
dollar of reserves deposited by its customers.
Question 2c
Leverage ratio is the ratio which expresses the relationship between the proportion of
debt held by a bank with the amount of equity and capital of the bank. It is an important tool for
any bank to assess its power to pay off its financial obligations. Since every company or bank
rely on its mixture of debt and equity to manage its operations, it becomes easier to know the
amount of debt held by the bank, which would be useful to pay off its obligations. Here, in the
case of WBB the leverage ratio is 2:1, which shows that the bank has a higher amount of debt
which would be used to finance its operations.
Question 2d
When the foreign depositor withdraws 100$ from the WBB account, he transfers it to the
overseas account of the same bank as a result of which there is an increase in the reserve ratio of
the which compels the bank to increase its interest rate, as a result of which there is a contract in
money supply.

4
MACROECONOMICS
Question 2e
Due to the mortgage crisis some people have defaulted on their loans, and their value has
decreased by 50. As a result of which the debt has increased by 50, as a result of which the
leverage ratio has increased. An increase in the leverage ratio indicates that the bank funds its
assets mostly with the help of its debt securities, rather than its equity.

5
MACROECONOMICS
3. Case Study:
The OPEC oil embargo on the United States was a sign of retaliation against the decision
of the US to resupply the Israeli militants during the Yom Kippur war. It was a decision to stop
exporting the vital raw material oil to the United States. The twelve members nations of
the Organization of Petroleum Exporting Countries had agreed to put the embargo on October
19, 1973. As a result of which, the prices of oil has quadrupled in the next six months. The prices
had remained high even after the ban had ended in March.
Question 3a
The prices saw a huge increase since 1971 where in terms of nominal price it was 3.60$ a
barrel and it increased to a whooping 12.21$ a barrel in 1975. The prices had remained at a high
level throughout that period even crossing a massive 25.10 $ a barrel in 1979. US oil production
had begun to decline steadily, and the US was unable to counter the excessive supply shortage,
which was caused by the trade embargo. This had caused a huge supply/demand imbalance
across the United States. There were various reasons which resulted in influencing the aggregate
demand and supply of oil in the US economy, but the most important one was the drastic
increase of the prices of inputs of the industries, where oil was considered a necessary raw
material. Due to this increase, there is a downward shift in the aggregate supply which resulted in
an increase in prices of oil products, output falls too and there is also a downward slopping in the
aggregate demand curve. As a result of Oil prices had quadrupled in a very span of time,
contributing to a deep global recession. This resulted in a drop in the demand for large cars
across the US. The car manufacturers were compelled to produce small cars and compact trucks
to reduce the demand pressure and steep oil prices. The consumers were compelled to reduce

6
MACROECONOMICS
their demands, price rationing was used was also introduced. Alternative energy sources such as
renewable energy, nuclear energy and domestic fossils were looked into to counter the effect of
this embargo.
Question 3b
Member countries of OPEC had gone back on their various agreements to restrict oil
production. The prices had fallen by more than 50 percent. This led to a decrease in the oil prices
across the United States. This fall had major long term and short term implications on the US
output and price level. In the short run, due to the occurrence of the oil price collapse, there was
a dramatic drop of revenue in the OPEC countries as a result United States was receiving oil at
the about 3.60$ a barrel which was synonymous with pre 1973 prices of oil in the US. It had led
to a shortfall in the revenues of many energy intensive industries of the United States specially
petroleum refineries. Due to a decrease in the prices of oil, a rightward shift occurred in the
aggregate supply curve, which led to a decrease in the prices of the oil related products and
consequently a drop in the prices. This had caused an increase in the demand of the oil products.

7
MACROECONOMICS
References:
Al Dulaimi, H.A.M., 2014. The Collapse of Crude Oil Prices: Cyclical Evolution or Market
Manipulation?. Economic Insights-Trends & Challenges, 66(4).
Baumeister, C. and Kilian, L., 2016. Forty years of oil price fluctuations: Why the price of oil
may still surprise us. Journal of Economic Perspectives, 30(1), pp.139-60.
BBC News. (2018). What is quantitative easing?. [online] Available at:
http://www.bbc.com/news/business-15198789 [Accessed 20 Mar. 2018].
Kilian, L., 2016. The impact of the shale oil revolution on US oil and gasoline prices. Review of
Environmental Economics and Policy, 10(2), pp.185-205.

8
MACROECONOMICS

9
MACROECONOMICS