Energy is a vital infrastructure for the development of any economy. Due to economic development and economic growth, the needs and desire of the people have multiplied in quantity and quality which necessitate the intensity in demand for different sources of energy including the fossil fuel sources like oil (petroleum products).

Oil is an import non-renewable, depletable and exhaustible energy source in meeting the basic needs of human beings i.e., from rural households to urban metropolis and from agriculture sector to transport sector. In case of rural households, kerosene is used for lighting purpose. Similarly, in case of transportation, oil plays the key role.

For the oil importing countries, oil price increase and economic growth are negatively correlated while all things being equal, the relation is positively correlated for oil exporting countries.

The price of oil and inflation are often seen as being connected within a cause and effect framework. As oil prices move up or down, inflation follows in the same direction (Anshul Sharma et al, 2012). In the case of oil and its price has been frequently increasing.

Our import dependence has reached 80.0 per cent and likely to keep growing. At the same time, the world oil prices have also constantly increased. The oil prices have started rising significantly since the beginning of the twenty first century. The immediate effect of the oil price shock is the increased cost of production due to increased fuel cost. As a reaction to inflation in the economy, the cost of production would also rise causing a decrease in supply.

On the other hand, inflation implies a fall in the purchasing power of people; in short, oil price fluctuation has adverse effects on the economy (Jose De Gregorio et al, 2007). The improved macroeconomic policies in many countries today may also have contributed to a smaller passthrough. Finally, oil prices are not entirely exogenous to the general equilibrium of the world economy and the reaction of world inflation and output to an oil price rise will depend on its nature. This paper analyses the impact of international oil prices and domestic oil price pass-through policy on major macroeconomic variables in India with the help of a macroeconomic simulation model.