ABSTRACT
Assume that OECD’s demand for oil is insensitive to price, and that OPEC always spends all its income on tradables. The price rise is then just equivalent to a transfer of income from OECD to OPEC (see Chapter 15). OECD reduces its expenditure and OPEC increases its by the same amount. However, the composition of their expenditure differs: OECD will cut back on both tradables and non-tradables, whereas OPEC will, by assumption, spend only on the former. The result is excess demand for tradables and excess supply of non-tradables. This will be eliminated by higher relative prices for tradables, and, assuming some mobility of factors of production between sectors, a shift in output away from non-tradables and towards tradables. If we identify tradables as manufactures and non-tradables as services, OECD is forced to industrialise to’pay for the higher-priced oil.
