In a physical system, energy is very important as it is the ability of that system to do work. Work, on the other hand, can be defined as the force acting through a given distance. Energy is always equivalent to the ability to pull or push against basic forces of nature like force of gravity.1
Energy is the main driving force behind manufacturing processes. Lack of energy can cause many manufacturing processes to get stalled. Therefore the price of energy has a direct impact on the final cost of the manufactured goods.
Energy is very essential to the economic and social development and overall improvement in the quality of life. Energy is used in the manufacturing process which has a direct impact to the quality of production realized.
The effect of the increase in price of energy on the overall cost of goods and the overall manufacturing process can be analyzed as shown below.
Most of the energy which is used in the manufacturing process is energy from fossil fuels and electricity. Energy from fossil fuels is used in almost all parts of the country as opposed to energy obtained from electricity which are dependent on the availability of electricity.
Energy has a direct impact on the nature of manufacturing processes and also determines the overall price of the produced commodity. When the cost of energy used to produce a particular kind of good is high, the overall cost of that particular kind of time will also be high.
The effect of the Energy on the price of an item can be analyzed as shown below:
1. Examine manufacturing as percent GDP at certain period of time and energy prices at the same period.
From the graph shown above, the cost of materials is high and this is attributed to the high cost of energy. Eventually the overall cost of a manufactured product will be high. This is because the manufacturers will have to compensate the amount of money they used during the production. When the cost of goods is high, many consumers will tend to shy off from obtaining that commodity. Once a commodity is no longer on demand, it will result into losses to the manufacturers who will in turn respond by lowering the amount of that good produced in their firms or deciding to do away with it completely. This means that when the cost of energy is high, then the cost of manufacturing will also be high and eventually resulting into a reduction in the amount of manufacturing.
2. Effect of the price of raw materials to price of manufactured goods
Form the graph above, an increase in the price of energy will result into an overall increase in the price of goods. When the cost of raw materials is increased, there will be a direct effect in the price of the manufactured goods. This will have an impact in the amount of goods manufactured from the raw materials produced using that kind of raw material.
Raw materials index price chart.
From the chart shown above, it is clear that the as cost of raw materials increase, the cost of manufacturing will also increase and this will result into an overall increase in the price of the manufactured goods.
The relationship between Manufacturing Production and GDP
In the year 2001, there was a sharp divergence between to similar economic indicators namely the goods output component of GDP and the manufacturing component of industrial production.3
Manufacturing Production and Goods Output
The manufacturing production is a very strong measure of the value added of factories. In this study we are also going to examine the behavior of other factors like imports.
Manufacturing production and goods output has several differences but they also posses some unique similarities.
The chart below shows a comparison between the movements of two adjusted series over the long term. Goods output has been consistently growing more strongly than manufacturing production.
Goods Output and Manufacturing Production in Cyclical Downturns
According to the chart above, the more peculiar experience is that of 1990-91 as the swing in goods output was then comparable to the swing in manufacturing production.
Retail Output and Consumer Spending on Goods
Consumer goods appear to require a higher fraction of service inputs to bring to market than the capital goods. A drop in spending and a decline in production may involve a drop in related service sector inputs.
Goods Output, Manufacturing Production, and the Composition of Private Demand for Goods
The above chart indicates the performance of goods output relative to the manufacturing, production and consumer spending.
Example: Car sales in USA when energy prices are high
When the prices of energy are high, the number of car sales in the USA dropped drastically. This was due to the following reasons:
i. Cost of production
The cost of producing/manufacturing the cars was very high since the raw materials used in the manufacture of the cars are produced from processes which involve the use of energy. As the price of the fossil fuels increased, the cost of manufacturing these materials also increased further thus resulting into a cumulative effect in the overall price of the cars. This made many people to shy off from buying cars in the US during this time.
ii. Cost of operation
The cars are energy dependent in operation. Most cars rely on fossil fuels to operate. When the price of energy was high, fewer cars were sold as the cost of operating these vehicles was very high. Since the cost was very high, many people ventured into acquiring the cars since no one was willing to spend more money to operate the cars.
Energy price fluctuation and effects
Analysis of the relationship between energy prices Vs demand for manufacturing. The periods between the year 2003 -2008, the energy price in the US increased rapidly thus resulting into a corresponding increase in price of goods and a consequent decrease in demand for manufacturing.
The following took place:
i. Increase in energy cost
ii. Increase in transportation cost for raw materials
iii. Increase in overall cost of manufacturing
iv. Increase in price of goods
v. Increase in the operation costs for goods which were energy dependent like cars
vi. High prices meant low purchases
vii. Low purchases meant low demand
viii. Hence the demand for manufacturing reduced drastically
All the above are interrelated and a change in the first aspect affects all the factors coming below it.
Manufacturing industry relies solely on energy for it operation. High cost of energy leads to high cost of manufacturing which also leads to high prices being set for the manufactured goods. This attempt by the manufacturers to set high prices for the produced goods so as to recover their capital and cost of production is not always met positively by the buyers. Most buyers will tend to shy away from using such items with high price. This will result into low sales. Once the manufacturers realize that they are not making a catch from their efforts to produce the good, they will either reduce its production or stop producing the good at all. Hence at the end of the day, the increase in energy price causes a reduction in production.
1. Bryan Burrough. The Big Rich: The Rise and Fall of the Greatest Texas Oil Fortunes. Penguin. 2010
2. The US Department of Commerce
3. Dahl Carol A. International Energy Markets: Understanding Pricing, Policies and Profits. Penwel Books Publishers, 2004.
4. Daniel I. Jones. Lean Thinking: Banish Waste and Create Wealth in Your Corporation
5. Jeffrey K. Liker. Kaizen for the Shopfloor Learning Package: Becoming Lean: Inside Stories of U.S. Manufacturers
6. Kiyoshi Suzaki New Manufacturing Challenge: Techniques for Continuous Improvement
7. Michael D. Regan. The Kaizen Revolution