1. IntroductionMicroeconomics is the study of the economic behaviour of individuals or a particular market. In this report, we would be studying the market of oil. Oil is considered as the biggest sector in the world in terms of dollar value. It is widely produced in countries like the United States, Russia, Saudi Arabia and China. But despite so, the demand and supply of oil had been on a decline due to various factors. This report will state the problems that the oil sector had been facing and 2.
ScarcityIn 2017, ports along the Gulf of Mexico are closed to fuel barges. Part of the biggest pipeline between Texas and New York has stopped flowing, refineries and gas stations are flooded. This caused Texas to run low on diesel supplies. This is because of the fallout from Hurricane Harvey’s devastation.
Price of oil increased subsequently and this might increase the consumer shortage of fuel. Due the the hurricane, the average price of a gallon of regular gasoline increased 5 cents from the day before to $2.45 and contracts on September wholesale deliveries rose to 25.5 cents a gallon.
When there is a consumer shortage of fuel, it will cause the demand to increase as people need the fuel, and when the demand increases while the supply remains the same, the price will increase the ths resource is scarce as there is limited supplies and unlimited demand, hence the prices are increased due to scarcity. Another thing that can be seen from the article is about negative spillovers, like how there was a hurricane in ports along the gulf of mexico and how there is an impact on the oil industry which affects the gasoline pumps stations causing there to have lesser oil and ultimately increasing the price of oil.3. Demand and Supply3.
1 DemandDemand of a good refers to the entire range of quantities consumers are willing and able to buy at different prices, in a particular time period, ceteris paribus.Global demand of oil is increasing faster than expected according to the International Energy Agency (IEA). In the second half of 2017, it has increased by 2 million billions per day (mb/d), or 2.4 percent. At the end of 2017, demand grew by 2.
3 million barrels/day or 2.4% for 2017. As a result, IEA is confident that shifting fundamentals will allow demand to catch up with supply. From the graph below, we can see that throughout the years, from 2013-2016, the demand for world oil has been fluctuating with no steady increase or decrease. However, in the 3rd quarter of 2015, the demand had a significant increase, exceeding 96 mb/d. This could be due to the cause of determinants which will be covered in the next part.
Also, according to the law of demand, it states that there is an inverse relationship between the price and the quantity demanded of a good. Hence, when the price of oil decrease (holding all other factors constant), the quantity demanded increases. In 2017, the price of oil per barrel had dropped from $50 to $30, which leads to an increase in the quantity demanded of oil. This results in a downward movement along the demand curve which can be shown in the graph at the bottom .3.
1.1 Determinants of Demand There are 5 determinants of demand namely money income, price of related goods, tastes and preferences, expectations of customers and the number of buyers in the market. These affects the consumer’s willingness and ability to buy goods. In this report, we will be focusing on 2 of it.One determinant which affects the demand of oil is the money income of consumers. The United States is considered one of the largest consumer of oil in the world.
The Hurricane Harvey that took place in the United States in 2017 had led to the decrease in money income of the residents as many lost their homes and their source of income. As the money income of consumers decreases, the demand of oil decreases as consumers may not be able to afford it. This would lead to a leftward shift of the demand curve.Another determinant which affects the demand of oil is the number of buyers in the market. As the world’s population grows, the demand for oil increases as there will be an increase in the number of buyers in the market, A larger amount of oil will be needed to meet the demand. According to the U.
S. statistic, U.S. has led the world in global oil consumption with more than 18 million 42-gallon barrels consumed everyday across the country. Also,the Chinese demand for crude oil and other industrial commodities over recent weeks and months as the Asian country builds stockpile. As the number of buyers in the market increases, the market demand of oil increases as well and hence, there will be a rightward shift of the demand curve. 3.
2 SupplyThe supply of a good refers to the entire range of quantities supplied of a good at prices, ceteris paribus.Due to the unforeseen events like the Hurricane Harvey, the production of oil in 2017 had been disrupted and the global supply of oil had experienced a decline. The occurrence of these events had cut about 200,000 barrels of oil produced per day in August 2017 and had also led to some oil refineries to cease their production. The net global supply of oil had dropped by 720,000 barrels per day in August and it was estimated that there would only be 300,000 barrels of oil produced per day in September for 2017.
Even though the demand of oil had also fell in 2017, the decrease in supply of oil had outpaced the decrease in demand of oil. From the 4th quarter of 2016 to the 1st quarter of 2017, the demand of oil had fell from 96.95 million barrels per day to 96.74 million barrels per day while the supply of oil had fell from 98.22 million barrels per day to 96.62 million barrels per day.
That is a drastic 1.63% of decrease in the supply of oil compared to the mere 0.217% decrease in the demand of oil in 2017.The law of supply states that a direct relationship exists between price and quantity supplied of a good, ceteris paribus. As such, as the supply of oil decreases, the price of oil decreases as well.
This leads to a downward movement along the supply curve because producers would be less willing to produce oil as oil had become relatively less profitable. 3.2.1 Determinants of Supply There are several determinants which affects the supply curve of oil.One such determinant which affects the supply of oil is the number of sellers in the market.
Being 2 of the top 10 proven oil reserves in the world, the turmoil in Libya and Hurricane Harvey in the United States which took place in 2017 had lead to a significant decrease in the supply of oil. As a result of these unforeseen circumstances, some of the oil refineries had no choice but to cease the production of oil. This in turn caused a drop in oil production as there will be lesser sellers who are able and willing to produce oil. Therefore, the supply curve of oil shifts left as a result of the decreasing number of sellers in the market.
Another determinant which affects the supply curve is the price of oil. Due to the decrease in barrels of oils produced in 2017, the total barrels of oil produced in 2017 is comparatively lesser than the previous year. Since there is a direct relationship between the price and quantity supplied of a good as stated in the law of supply, the price of oil decreases as the quantity supplied of oil decreases. As a result, producers are less willing to supply greater amounts of oil as oil has become relatively less profitable to produce.
As the price of oil falls, it leads to a downward movement along the supply curve. 4. ElasticityOil is generally inelastic as it is a necessity. Oil can be turned into other resources such as petrol, gasoline, diesel etc, which are always in demand. Large factories that produce consumer goods are a good example. In the past, oil was too expensive to exploit due to the expensive machinery, intense labour, ad high opportunity cost.
It has now become economical due to the rising price, and lower opportunity cost.Unfortunately, there is something to worry about, at least if we want a healthy economy. In recent years, oil reserves have begun to become expensive to exploit once again. One barrel of oil now costs more to produce than before and takes a longer time to produce each barrel of oil after drilling each oil well. That means it takes longer for oil supply to respond to changes in price.Small changes in the oil price elasticities have large and material implications for quantifying the determinants of fluctuations in oil prices and oil production. As at November 2017, the price elasticity of oil demand is -0.04%.
This means that every 10% increase in oil prices implies a 400,000-bpd decline in oil demand, given that total demand is at nearly 100 mb/d.This negative price elasticity of oil demand means that a percentage change in price of oil results in an even smaller percentage change in the quantity demanded of oil. It is price inelastic as consumers are not so responsive to the changes in oil prices.This is because there are no available substitutes in the market for oil, and oil is an essential in everyone’s life. Thus, when the price of oil changes, consumers have no choice but to accept the price changes. h 5. Market StructureOil will be categorised under the oligopoly market structure.
It is a market with few producers and many buyers and this allows the producer to have the upperhand in controlling the market.There is a mutual independence whereby each firm must weigh the effect of its own policies on rivals’ behaviour. There are several barriers to entry of new firms such as economics of scale, high set up cost, existence of established name brands, legal restriction and control over essential resources. There are two varieties of oligopoly- pure and differentiated. Oil is considered pure because it is homogenous as there are greater interdependence among few dominants firm (i.e.
US, Iraq Russia); greater sense of sensitivity of changes in pricing policies because a change in price will most likely trigger a strong reaction from rivals and vice versa. Each firm will also react to other firm’s changes in output,product quality and advertisement.Behaviour:There are two types – non price competition and collusions and cartels.Non price competition refers to a firm’s behaviour which is designed to increase its market share (or demand) without changing its price.
This includes advertising,product differentiation and barriers to entry.Collude is to agree on a price and output level in order to increase profit and decrease competition.Cartel is a collection of firms that agree to coordinate their production and pricing decision. Some cartel are worldwide in scope .(i.
e. OPEC). If each country in an oligopoly sells homogeneous product like oil, the demand curve of each firm will be a horizontal market demand (Fig a). However, if the oil-producing country comes together and form a cartel like OPEC to decide on their price and output, they will have a downward sloping market demand. Benefits:All the members in OPEC have a greater certainty about each other’s behaviour and they can organise effort to block new entry and thus increase profits.
Problems:Since different country may incur different cost, it is hard for all the countries to agree on a certain price of oil or level of production.They may also cheat on the agreement and earn more profit by producing an amount that exceed the target set for them. This may result in internal conflict among the members.