Oil is the particular form of energy that is traded globally and its prices depend mainly on the transport costs from major refining centers. A change in oil prices affects households as it poses an indirect and direct effect on household incomes. These indirect and direct links imply that higher oil prices are associated with disruptions of household budgets.
Oil markets and household budgets
Household incomes are impacted directly through the higher prices of oil products consumed, whereas they are impacted indirectly through the prices of commodities manufactured by other sectors due to increases resulting from input-output linkages with the oil industry. Households that allocate greater portion of their budget to oil commodities experience an increased magnitude of the direct effect. Similarly, the indirect effect will be significant for households that allocate a substantial amount of income to commodities whose prices are significantly influenced by oil prices. Following increasing oil costs, higher energy prices decrease household disposable income and constrict the budget for other expenditures ( Bodenstein, Erceg & Guerrieri, 2011). Simultaneously, an increase in gasoline prices elevates the operating costs of machinery, reducing the probability of their purchase.
Consequently, the decline in disposable income triggered by oil price fluctuations might discourage further household expenditure. The demand of oil is moderately high when prices are high, implying that oil companies should implement efforts in identifying more oil sources. At this time, oil companies accumulate substantial amount of capital. Alternatively, when oil prices decrease it implies that the commodity is in adequate quantities. When the prices are high, oil companies accrue substantial profits, while the consumers and households are required to designate more capital to oil-related commodities. This interferes with a household budget since households are required to reduce other expenses to accommodate the increasing oil costs. Changes in household expenditure due to energy may result from changes in quantities, prices or the number of household members using the given type of energy, and total household income. Oil supply and demand shocks impact household disposable income available for other expenditures through gasoline and energy prices .Interferences in the flow supply of oil impose a limited role for the ICS, since they only pose marginally significant outcomes on expected inflation , while they do not influence future expectations about real household income (Güntner & Linsbauer, 2018). Other oil demand shocks, aside from aggregate demand shocks, cause pronounced increments in expected interest rates and inflation resulting in corresponding decreases in anticipated real household income in the short-term. On one hand, an increase in the global demand for industrial goods resultant from global real economic activity may benefit households while on the other hand, this anticipated increase in household income may be affected by increments in future energy prices.
With increasing diesel prices, affluent households are mostly affected while low-income households are majorly affected by increases in higher gasoline and kerosene prices. Overall, the outcomes of energy prices on household budgets in association with expenditure per capita demonstrate a U-shaped relationship (Kpodar & Djiofack, 2010). Nevertheless, despite the type of oil product, high-income households benefit significantly from petroleum price subsidies. Therefore, oil price subsidies are rather ineffective in preserving the income of low-income households in comparison to a targeted subsidy.
Conclusively, when oil markets increase oil prices, households tend to suffer. However, the low-income households are mainly affected with these changes compared to high-income households. Imported premium products as well as locally-manufactured commodities increase due to an increase in oil prices, in turn affecting other household expenses.
Bodenstein, M., Erceg, C. J., & Guerrieri, L. (2011). Oil shocks and external adjustment. Journal of International Economics, 83(2), 168-184.
Güntner, J. H., & Linsbauer, K. (2018). The effects of oil supply and demand shocks on US consumer Sentiment. Journal of Money, Credit and Banking, 50(7), 1617-1644.
Kpodar, K., & Djiofack, C. (2010). The Distributional effects of oil price changes on household income: Evidence from Mali. Journal of African Economies, 19(2), 205-236.