Economics 201

Case of the Day: Tracing the Effects of the Oil Embargo

In 1973-74, OPEC imposed an embargo on exports to the United States and subsequently increased the price of oil fourfold. More recently we have all experienced another rapid increase in world oil prices that is causing significant readjustments in the U.S. economy. The case asks you to consider how oil shocks affects other markets in the U.S. economy, including both product and factor markets.

Oil is used to produce many other goods and services in the economy, and is also used heavily directly by final consumers. The best data on use of particular commodities within the economy comes from the detailed input-output tables that are published by the Burean of Economic Analysis. Table 1 shows the use of crude petroleum and natural gas in the U.S. economy in 1992. (This is the closest input-output table I could find in the Reed Library. Keep in mind that changes in oil prices would affect how it is used and that the 1992 numbers may be somewhat different than those of 1973-74 or those now.) The BEA tables do not report crude petroleum separately from natural gas.

Table 1. Uses of crude petroleum and natural gas

As you can see, the vast majority of crude petroleum and natural gas goes to three industries: petroleum refining, gas utilities, and back into its own industry. The use of crude oil and gas within the crude oil and gas industry is probably mostly as a fuel for oil wells and drilling facilities, so we may neglect this and focus on the net output of the industry. The part of net output that goes to the gas utility industry is almost surely dominated by natural gas and not crude petroleum, so it seems safe to conclude that our focus in analyzing the impact of a change in the availability of crude petroleum should be on the petroleum refining industry.

Table 2 presents a similar breakdown of the 1992 use of the output of the petroleum refining industry.

Table 2. Use of petroleum products by industries, 1992.

Clearly, some sectors consume very large amounts of petroleum products while others consume relatively little. However, Table 2 may be somewhat misleading because some industries produce much more output than others. A large industry may use a lot of petroleum even if oil is not one of its most significant inputs. Table 3 shows industries for which at least 5 cents of petroleum products are needed for each dollar of output. The numbers in the table show the amount of petroleum products that are used directly and indirectly (i.e., as inputs for the production of other inputs) to produce one dollar's worth of each industry's output).

Table 3. Amount of refined petroleum used directly and indirectly to produce one dollar of industry output.

Table 3 gives a different perspective from Table 2. While Table 2 shows the channels by which oil will have the largest effects on the economy, Table 3 shows which industries (large or small) are going to be most strongly affected.

Input-output tables give detailed descriptions of the interindustry flows of intermediate goods. However, we must remember that much of the petroleum products used in the United States are used directly by households. In 1992, households bought 53.355 billion dollars of petroleum products (at producer prices, not including taxes, transportation, and markup), accounting for about 1.6% of total consumption expenditures. (At purchasers' prices, which include taxes, transportation, and markup, petroleum expenditures were 116.039 billion, or about 2.5% of expenditures.)

Questions for analysis

1. Based on Tables 2 and 3, what are the major channels by which an oil shortage would affect the economy through its role as an intermediate input? Describe the effects on the supply and/or demand curves in a typical affected industry.

2. The U.S. auto and steel industries are often considered to have been strongly affected by the oil embargo, yet these industries do not have large values in Tables 2 and 3. Explain why the demand for U.S. produced autos and steel might be affected, given that oil products are not important inputs. Are there other industries that do not have large values in Tables 2 and 3 that might be affected positively or negatively through similar channels?

3. Changes in the product market also cause adjustments in the supply and demand for factors of production. What are some examples of particular kinds of labor and capital that would be strongly affected by an increase in the cost of petroleum products? Explain how they are affected and what happens to their supply and demand.

4. If you had access to the necessary data, how would you look for these effects on firms and factors of production in various industries? In other words, what variables would you examine and what kinds of changes would you expect to find occurring after an increase in oil prices?