ChainWhat it assumes · how to break it
Start
World oil prices rise sharply, raising costs for energy-intensive industries such as airlines, haulage and chemicals.
1
As a result, firms' costs of production rise, because oil is an input into fuel, transport, plastics, chemicals and much electricity generation.
costs of production · raw materials
costs of production · raw materials
Assumes: Oil is a significant input for most firms.
But: Service-sector firms such as banks and software companies use little oil directly, so their costs rise much less than those of airlines or hauliers.
2
This means the short-run aggregate supply curve shifts to the left, as firms need higher prices to supply the same output.
short-run aggregate supply (SRAS)
short-run aggregate supply (SRAS)
Assumes: Firms pass the higher costs on in prices.
But: Firms facing strong competition or price-elastic demand may absorb part of the rise in their profit margins.
3
This means energy-intensive firms cut output and some become unprofitable, so their derived demand for labour falls.
derived demand for labour
derived demand for labour
Assumes: Firms respond to lower profits by cutting output.
But: Firms that expect the price rise to be temporary may keep output and staff and accept lower profits for a while.
4
Therefore, firms cut hours and jobs rather than keep paying staff they no longer need.
labour hoarding
labour hoarding
Best link to attack
Assumes: Firms do not hoard labour.
Assumes: Firms do not hoard labour.
But: Firms that face high costs of hiring and training may keep skilled workers through a downturn they believe is short, so employment falls less than output.
5
Consequently, unemployment rises, first in energy-intensive industries and then more widely as squeezed real incomes reduce consumption across the economy.
cyclical (demand-deficient) unemployment
cyclical (demand-deficient) unemployment
Assumes: Workers who lose jobs cannot move easily into other sectors.
But: Some sectors, such as domestic energy production and insulation, expand when oil is dear and may take on workers.
End
Employment falls and unemployment rises, concentrated in energy-intensive industries.
Evaluation chain
- E1However, the fall in employment depends on firms choosing to cut jobs rather than hoard labour.
- E2Because hiring and training skilled workers is costly, firms that expect the oil price to fall back will keep staff and accept lower productivity for a time.
- E3As a result, employment falls by less than output in the short run, and only falls sharply if the higher price lasts long enough to change firms' expectations.
- E4So a brief oil spike may cost few jobs, while a sustained rise, as in the 1970s, causes a much larger rise in unemployment.
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Questions this answers
- Assess the likely impact of a rise in oil prices on unemployment in the UK.
- Explain why a supply-side shock can raise both inflation and unemployment.
- Discuss whether an oil price shock would affect all industries' employment equally.
Diagram
AD/AS diagram showing SRAS shifting left and real output falling, linked to a fall in the derived demand for labour; a labour market diagram with labour demand shifting left can support it.
Reverse and related
Fall in world oil prices → costs fall, firms expand output and the derived demand for labour rises.