The Economic Impact of Rising Oil Prices in Automotive Industry

The rise in the oil prices plays a major role in the automotive industry. “The world consumes over 82 million barrels of oil per day (BPD), with the united states taking roughly 20 million BPD” (McFarlane). Oil provides 97 percent of the transportation fuels that helps to run the cars, trucks and other vehicles in the nation’s highway (Heinberg). Thus, when the price of the oil rises, it clearly concerns the auto industry because the companies are competing with each other to meet the new demands for more fuel efficient consumer conscious at reduced price.

There is no doubt that it is affecting the profit margin of the company. Moreover, increase oil price is also affecting the type of vehicles demanded by the customer and the way those vehicles are designed. The demand of oil and the difficulties in oil refineries is the major cause for the increased oil price. Oil is used mainly for two purposes: Firstly, to make the gasoline and secondly in tire production. The gasoline prices in the US have increased dramatically during the last few years reaching averages over $ 3. 00 per gallon (EIA-Energy Information Administration).

Oil is the major ingredient in the production of tires. Increased in oil prices means increase in the cost to make the tires, increase in the cost to heat or cool the plant where tires are made and lastly increase in the cost to ship the tires. The tire makers are increasing the price of the tires because of the increase in the price of the oil. Both gasoline and tire production affects the auto industry as the increase in the price in gasoline and tire production affects their profit margin. The current increase in the price of the oil began early in 1999 due to various reasons.

One of the reasons is the dispute in the Middle East beside with negligible changes from Organization of Petroleum Exporting Countries (OPEC). Due to this, the U. S. Government had kept the oil price very high to this very day. Recent increases in the price of oil have reached their highest level since the Gulf War, and further increases could hurt U. S. economic growth including in the growth of auto industry. The effect of higher oil price could show up in the feebler vehicle sales. But that was not the case in mid 1940s. The auto industry was seen as both a leader and a beneficiary of American growth and the economic achievement.

More than 50% of the vehicles sold were produced by General Motors (Abernathy and Clark). The U. S. “Big Three”- General Motors, Ford, and DaimlerChrysler- motor vehicles corporations made a range of vehicles that met every consumer needs. But in early 1979 when OPEC suddenly increases the price of the oil, consumers reacted by shifting towards small, fuel efficient cars. The “Big Three” and other small car companies could not keep up with the demands. So, people shifted towards the small fuel efficient imported vehicles. Today, “Big Three” only produce 60% of all automobiles and light truck sold in the United States (Abernathy and Clark).

These changes have had major effect on the structure and location of the US motor industry. Though “Big Three” still dominate the market, other foreign companies are also on their way in this class. The sale of Japanese cars increased because they meet the efficiency standards that American cars did not. Cars with big engines and large heavy bodies were no longer made in order to preserve oil and boost the economy. The increase in the oil prices impacts the auto industry by direct, indirect and induced economic multiplier effects (Michigan Public Service Commission).

Direct impacts are the increased expenses for purchased oil or oil products. Indirect impacts includes the changed prices paid for other products and services such as tires which pass along the higher fuel costs in the automobile prices. Lastly are the induced impacts of price increases. The former two causes vehicle prices to rise and this feeds through wage increases, which raises labor costs, which in turn, raises the price of the product that is the price of the automobile in the auto industry.

Oil prices are largely driven by the global supply and demand. When oil prices rise, it becomes more expensive to manufacture and transport the goods, in this case, autos. Deputy CEO An of Geely, a private Chinese company, expresses his disappointment by the oil- price changes. He added that changes in the oil prices have a bigger impact on the auto industry as this makes a lot of demands on the carmakers and raises the standard and they have to design the product thinking more about the fuel consumption (O’Rourke).

The increase in the cost to produce the products must be factored in the higher price of the product. The sale of automobile is affected by the rise in the oil prices and there is a possibility that the volume of sale may decline as the result of higher prices that the producers now have to charge for their products. Even though the auto industry decreases its price significantly, their sale would decrease. This is because the demand of oil is inelastic in the short term. This can be better explained by giving example. If the oil price rises, the economy doesn’t stop.

People still have to go to work. The result of an inelastic demand for the oil is that people will continue to buy and pay more for the oil because they do not have immediate alternatives, but they will change their spending behavior elsewhere because of their fixed amount of income (Enzo). In the long run, people would find the alternative, the alternative such as riding a bicycle instead of autos. If the consumers are forced to pay higher prices for the fuel, then they will have less money to spend because of their fixed income.

So, they will buy the product that will help them to maintain their budget. As a result, the volume of sale in automobile declines in response to the higher oil prices. According to Ira Kalish, a director of global economics and consumer business at Deloitte Research, “consumer spending in the US has slowed and the mix of automobiles purchased has shifted” (Brown). The increase in oil prices tends to put pressure on the inflation and restrain economic growth in 2006. In January 2002 the price of oil was $ 20 a barrel which increases to $65 in 2006.

This fluctuation in prices hampers the auto industry which produces energy- consuming products. (whitehouse. gov) source: whitehouse. gov Recommendation: Taxes make up the prices that we pay in oil. A substantial amount of money we are currently paying in not based on the laws of supply and demand. Therefore, at first legislation must be introduced that protects the individual citizens and businesses. Not only individual and manufacturers are affected by the rising oil prices but it is also affecting all the levels of society including drivers, carriers companies and firms.

Therefore, all level of auto industry should come together and pressure the Congress in support of a bill that protects the US from irregular market price movement. This bill would force the internal US market correction to take appropriate action when the oil prices are raised unexpectedly by the OPEC partners. Secondly, the government should follow aggressive policies that reduce the demand for the oil. Because oil affects the auto industry both directly and indirectly, progressive policies should focus on helping working families afford efficient cars and trucks that reduces their expenses.

Thirdly, as proposed by Amory Lovins, Chairman and Chief Scientist of the Rocky Mountain Institute, and author and co-author of many books on renewable energy and energy efficiency, federal procurement of large volume of efficient cars for lease to qualifying buyers and helping people to obtain credit to buy efficient vehicles who currently do not qualify for new car loans (Podesta). This would help the auto industry as well. Fourthly, government should reduce dependence on foreign oil. Method to decrease oil consumption by the vehicles should be addressed as large part of the oil consumption is used in these kinds of vehicles.

Last but not least, government should give more priority on research into alternative energy sources. In the nutshell, we can say that automobile industry is in deep trouble because of the rise in oil prices. The rise in oil prices is not only affecting its production capacity but also forcing the industry to cut down the human resource to maintain the minimal profit or break even. The automobile industry, for long period of time, played a crucial role in the social and economic life of the nation. I believe it is the time to help them to overcome from their difficulties. The government should be committed that the rise in oil price will have no effect or less effect in the automobile industry as well as in the individual lives.

Works Cited

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  • O’Rourke, Breffni. “China: Beijing Hopes To Tackle Crowded World Car Market. ” Format Online. June 16 2006. November 18 2007. < http://www. rferl. org/featuresarticle/>.
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  • Whitehouse. “The Role of Policy in Building a Strong Economy. ” 2007. November 13 2007. Format Online. .