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9 - Class Read 2

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23 views4 pages

9 - Class Read 2

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3.

5
pound)

per
2.5
(dollars P*= 2.00

Price
15 P=1.79

0.5 Q'=12
l= 10

0+ 15
20
0 5 10
tons/year)
Quantity (million metric

FIGURE 2.20 Copper Demand and Supply


20-percent decline in demand Jeads
The shift in the demandcurve correspondingto a
to a 10.5-percent decline in price.
Market
EXAMPLE 2.6 Upheaval in the World Oil
world oil market
Since the early 1970s, the
OPEC cartel and
has been buffeted by the
Persian Gulf. In
by political turmoil in the output,
1974, by collectively restraining
of Petroleum
OPEC (the Organization
oil
Exporting Countries) pushed world
prices wellabove what they would have
been in a competitive market. OPEC could
do this because it accounted for much of
prices shot up again, as the
world oil production. During 1979-1980, oilIran-Iraq
Iranian revolution and the outbreak of the war sharply reduced
Iranian and Iraqi production. During the 1980s, the price gradually declined,
as demand fell and competitive (i.e., non-OPEC)supply rose in response to
price. Prices remained relatively stable during 1988-2001, except for a tempo
rary spike in 1990 following the Iraqi invasion of Kuwait. Prices increased
with
again in 2002-2003 as a result of a strike in Venezuela and then the war
Iraq in the spring of 2003; they continued to increase during 2005-2007 as
a result of rising oil demand in Asia and reductions in OPEC output.
Figure 2.21 shows the world price of oil from 1970to 2007, in both nominal
and real terms.
The Persian Gulf is one of the less stable regions of the world--a fact that has
led to concern over the possibility of new oil supply disruptions and sharp
increases in oil prices. What would happen to oil pricesin both the short run
and longer run--if a war or revolution in the Persian Gulf caused a sharp cutback
in oil production? Let's see how simple demand and supply curves can be used
to predict the outcome of such an event.
CHAPTER 2 Derman sed Sut

carrei
Proededars
per
Real l'ce ($2**)y

Nominal I'ice

1975 1o80 1000 1905 2000 2010

FIGURE 2.21 Price of Crude Oil


The Ccartel and pohtical events caused the pice of oil to rise
It later fvll as demand and supply adusted. sharply at times

Because this example is set in 2005-2007, all prices are measured in 2005
dollars. Here are sOme rough figures:
" 2005-2007 worldprice = $50 per barrel
. World demand and total supply = 34 billion barrels per year (bb/yr)
" (OPEC supply = 14 bb/yr
" Competitive (non-0PEC) supply =20 bb/yr
The tollowing table gives price elasticity estimates for oil demand and
supply:l2

Short-Run Long-Run
World denmand: -0.05 -0.40

Competitive supply 0.10 0.40

You should verify that these numbers imply the following for demandand
competitive supply in the short run:

For the soures of thee numers and a mon detatlat discussion of OTEC lprcing, see Robert S
Pndyck Gatns to Irtuers from the artelzaton of txhaust1tle ResouNS Ree o Economcs
and Stattsths (May 1978) 28 51, lames MGnttin and Davd }. ene. OPEC Reharer and Worid
Od Prces (London Alen and Unwi, 198), and JohnC# Cper, Irie Elasticity of Demand for
Crude hl Estimates for 23 Countries, Organtzatem of the Petroleum Exrorting Countries Revseuw
(March Z003)
ir.troduction: Markets and Prices

Slhor-run demand: D= 35.5 - 0.03P


Of
Short-run competitive sSupply: Sc =18.0 +0.04p
course, total
constant at 14 supply
bb/yr.
is
competitive
Adding this 14supply
plus OPEC supply, which
we take as
above, we obtain bb/yr to the competitive
the
following! for the total short-run supply: supply curve
Stort-run total supply: S, =32 +0.04P
You should verify
that the quantity demanded and the total
are equal at an equilibrium
You should also verify price ofCorresponding
$50 per barrel. quant1ty supphied
the long run that the demand and supply
are as follows: curves
for

Loing-run demad: D= 47.5 -0.27P


Long-run competitive supply: S = 12 + 0.16P
Long-run total supply: S, = 26+0.16P

Again, youcan check that the quantities supplied and demanded equate at.
price of $50.
Saudi Arabia is one of the world's largest oil producers, accounting for
roughly 3 bb/yr, which is nearly 10percent of total world production. What
would happen to the price of oil if, because of war or political upheaval, Saudi
Arabia stopped producing oil? We can use our demand and supply curves to
find out.
For the short run, simply subtract 3from total supply:
Shortrun demand: D=35.5- 0.03P
Short-run total supply: S = 29 + 0.04P

By equating this total quantity supplied witlh the quantity demanded, we can see
that in the short run, the price will nearly double to $92.86 per barrel. Figure 2.22
shows this supply shift and the resulting short-run increase in price. The initial
equilibrium is at the intersection of S, and D. After the drop in Saudi production,
the equilibrium occurs where S' and Dcross.
In the long run, however, things will be different. Because both demand and
competitive supply are more elastic in the long run, the3 bb/yr cut in oil produc
tion will no longer support such a high price. Subtracting 3 from long-run total
supply and equating with long-run demand, we can see that the price will fall to
$56.98, only $6.98 above the initial $50 price.
Thus, if Saudi Arabia suddenly stops producing oil, we
about a doubling in price. However, we should also expect toshould expect to see
see the price grad
ually decline afterward, as demand falls and competitive supply rises.
This is indeed what happened following the sharp decline in Iranian
production in 1979-1980. History may or may not repeat itself, but if it and Iraqi
does, we
can at least predict the impact on oil prices. 13

13Youcan obtain recent data and learn more about the world oil
the American Petroleum Institute at www.api.org or the U.S. market by accessing the Web sites of
Energy Information Administration at
www.eia.doe.gov.
CHAPTER

Pneiilars
per
tatisis

harrel
2
per
(dllars

I'rice

FIGURE 2.22 Impact of Saudi Production Cut


Ihe tottl spyplis thesumotwnirt"tsy nithlN

wmputive supplv a mwh tounti the i ; t ll h

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