Forecast Models and Policy Analysis

The Case of Oil Prices

by Janet Syme


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The oil price forecasts made following the 1973 oil shock critically shaped the investment and energy policies implemented by industry and government. Even though these forecasts were made by different models and researchers, all of them predicted that oil prices would be over three times what they actually turned out to be in 1987. To determine why all these forecasts were so wrong, this Note compares the assumptions made by different models and the effect upon the forecasts of altering these assumptions. The results show that the probable source of error is the price elasticity of demand for oil used in the models. The actual elasticities are considerably higher than the elasticities assumed by the models, indicating the prevailing misconception that consumer demand response to changes in oil prices is small.

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