Effects of World Price and Oil Export Price Increases in the Framework of One-sector and Two-Sector Stylized Models

Interesting stylized models that discuss the implications of the oil boom or oil export price increase on an oil-rich economy must involve a tension between effects that tend to boost oil sector and harm non-oil sector and effects that vice versa tend to boost non-oil sector and harm oil sector. This paper explores such models and examines at large the implications of the oil export price increase through the prism of interaction between these two effects. This paper applies the 1-2-3-model of Devarajan et al. (1990) and develops two stylized models that examine the effects of the world price increase and oil export price increase on the economy respectively. A central feature of the developed stylized models is that they can distinguish between the two effects generated by the oil export price increase, namely the balance-of-trade effect and the import-competing effect. The balance-of-trade effect shows the response of the economy to the oil export price increase, depending on whether the economy runs a trade surplus or a trade deficit in the benchmark equilibrium, with the import-competing effect set equal to one. It shows conditions that cause changes in the producers’ real costs and hence determines which sector grows and which sector shrinks in the wake of the oil export price increase. The import-competing effect, under the assumption that trade is balanced, shows the effect of the variation in the Armington elasticity of substitution between oil goods in the second model and non-oil goods in the third model. It shows how competition between imported and import-competing goods affects producers’ real costs and hence determines which sector grows and which sector shrinks in the wake of the oil export price increase.