The dependence on oil has increased in many nations as a result of increasing industrialization and oil has been the factor of many crises as well as many wars. However, this assignment examines how the oil price shocks affect the unemployment rate. Our main objective is to see whether a change in the oil price will affect a change in unemployment rate at a later stage.

Oil price plays a very important role in an economy of every country. Oil is the main commodity that generates growth in an economy. Oil price fluctuation cause many problems in an economy such as high inflation, unemployment, and decline in GDP (Ling&Jones, 2011). Oil price increase can also contribute to an increase in the cost of production, which effects the number of employees. Industries are dependent on oil. An increase in the oil price will have major effect on production (Mellquist&Femermo, 2007). A higher cost of production because of a surge in the price of oil can cause people’s rate of consumption to decrease. Employee is also dependent on aggregate demand or people consumption. A reduction in demand also contributes to higher unemployment. In short, oil price shocks can increase the marginal cost of production in many industrial while reducing the production and thus increasing the unemployment.

In 1998 Alan Carruth, Mark Hooker & Andrew Oswald (C, H&O) modified the Shapiro & Stiglitz (1984) model by adding a role for input prices to create an equilibrium unemployment model (Carruth, 1998). In the C, H&O equilibrium unemployment, U*, is a function of five variables, as shown in the following equation:

According to the model, an increase in any of these five variables has a positive effect on U*, all else equal, with the exception of an increase in d, which has a negative effect. According to their logic, an increase in the price of oil will lead to less profit for the firms. To get back to zero-profit equilibrium one of the variables has to change, since interest rates are largely fixed internationally, the price of labour has to alter. Considering unemployment and wages to be connected inversely by a no-shirking condition, equilibrium unemployment must rise. This is the only thing that will make the workers accept a lower salary. This is how the oil price shocks affect the unemployment rate.

Besides that, from the seemingly contradictory evidence of macro and micro data, James Hamilton conclude that if the price of oil does not fall, the consumption of each consumer also will exceeds it so if the consumer spending increases by $ 1, the producer’s spending is reduced by $ 1, which is not really net economy. In 1988, James Hamilton mentioned a model is the decline of the oil price will increase the unemployment rate of the each oil industry sector such as the oil industry sales and service, and more in turn who sell to these suppliers (Hamilton, 2016). In addition, the oil industry developed two new oil drilling technologies-horizontal drilling and hydraulic fracturing. It affected the cost of the oil production become higher and this technologies can instead of labour. Therefore, some of the oil industry in order to avoid higher cost of production so they will reduce the number of workers and it will cause in the unemployment of oil workers (Wolla, 2015).