One of the central issues in international macroeconomics is relative price movements and their sources. One such price is the price of crude oil. An increase in oil price leads to a transfer of income from importing to exporting countries through a shift in terms of trade. The general mechanism by which oil prices affect the economic performance is well under-stood. However, the dynamics of these effects – especially the adjustment to the terms of trade – are uncertain.

The purpose of this paper is to analyse the impact of an increase in oil price on the terms of trade during the time period 1970 to 2004. The relationship between oil price and world business cycle as well as the relationship between oil price, GWP and Saudi Arabia’s export is also examined in this paper.

The regression results show that an increase in oil price has a negative impact on terms of trade for the net importing country. Whether an increase in oil price has a positive or no effect at all on terms of trade for the net exporting country cannot be told form the regres-sion results.