Many of the most disruptive events for the world's economies over the past several decades have originated in the world market for oil (Mankiw, 1998, pg 105). In 1970 s, members of Organization of Petroleum Exporting Countries (OEC) raised the world price of oil to increase their income and were most successful at maintaining cooperation and high prices in the period from 1973 to 1985. The price of crude oil rose from $2. 64 a barrel in 1972 to $11. 17 in 1974 and then to $35. 10 in 1981.
By 1986 the price of crude oil had fallen back to $12. 52 a barrel. In 1990 the price of oil was back to where it began in 1970, and it has stayed at that low level throughout most of the 1990 s. Ten years after the Gulf crisis, the price of Brent oil plunged 13%. This had showed how supply and demand could behave differently in both short run and long run. In my essay, I will mainly focus on how the market forces the supply and demand, the elasticity and the costs of taxation.
Demand is related to wants (Sloman & Norris, 1999, pg 5). If goods and services were free, people would simply demand whatever they wanted. Such wants are virtually boundless. Supply, on the other hand, is limited. It is related to resources.
The amount that firms can supply depends on the resources and technology available. Over the long periods of time, with high oil prices persisting, people tried to find ways of cutting back on consumption. People bought smaller cars and firms switched to other fuels. Less use was made of oil-fired power stations for electricity generation.
Energy-saving schemes became widespread both in firms and at home. Thus, Figure 1 shows that the long-run supply and demand curves are more elastic. In the long run, the shift in the supply curve from S 1 to S 2 causes a much smaller increase in the price. Figure 1: In the long run, supply and demand are relatively elastic, as in Figure 1. In this case, the supply curve would shift from S 1 to S 2 that will cause a smaller increase in the price. In the short run, it shows that both the supply and demand for oil is inelastic.
Supply is inelastic because the quantity of known oil reserves and the capacity for oil extraction cannot be changed quickly. Meanwhile demand is inelastic because buying habits do not respond immediately to changes in prices. Thus, Figure 2 shows that the short-run supply and demand curves are steep. When the supply of oil shifts from S 1 to S 2, the price that increases from P 1 to P 2 is large. This reduction in output needed to be only relatively small because the short-run demand for oil was highly price inelastic: for most users there are no substitutes in the short run. Figure 2: When the supply of oil falls, the response depends on the time horizon.
In the short run, supply and demand are relatively inelastic, as in Figure 2. Thus, when the supply curve shifts from S 1 to S 2, the price rises substantially The OPEC countries imposed an excise tax of so many cents per barrel on each barrel of oil produced in their countries. These taxes were well publicized and, like any excise tax, they were treated as a cost of production by any of the international oil companies operating in these countries. Thus, by increasing these taxes, the price of crude oil increases, since no company could afford to sell oil for less than its production costs plus the tax. When taxes are imposed in the market, the market would have an elastic supply and an inelastic demand.
It had been expected that the crude oil price would be pushed up towards the monopoly level, since it would increase their tax revenues. It was even estimated that hundreds of billions of dollars were transferred by this means from oil consumers to OPEC. Figure 3: In Figure 3, the supply of curve is elastic, and the demand curve is inelastic. In this case, the price received by sellers falls only slightly, while the price paid by buyers rises substantially. Thus, buyers bear most of the burden of the tax.
It was stated in the article that oil prices, which OPEC has attempted to keep within a $22 - 28 target range could still fall lower. Oil prices, however, have continued to fall. On the demand side, the development of energy-saving technology plus the increases in fuel taxes have led to a relatively slow growth in consumption. On the supply side, the growing proportion of output supplied by non-OPEC members, plus the adoption in 1994 of a relatively high OPEC production ceiling of 24. 5 million barrels per day, has meant that supply has more than kept pace with demand. The problem for OPEC is how to constrain output, despite the unwillingness of non-OPEC members to adopt quotas and the constant tendency of some OPEC members, such as Venezuela and Nigeria, to cheat by producing more than their quota.
Typically production by OPEC has been some 1 million barrels per day over the production ceiling (Sloman & Norris, 1999). The oil market shares in both England and U. S were threatened after the attack in U. S since two weeks ago. This has caused a decision in OPEC to limit its crude exports. As OPEC's decision to limit its crude exports, other non-OPEC producers were obtaining the benefit that was supposed to have.
This has caused the exports from other countries to increase therefore it brings more revenue to the non-OPEC producers. As a result of a decrease in oil prices, many oil producers would have to cut down its workforce. This is because when oil prices are low, the total revenue would also decrease. When the demand is at equilibrium the total revenue is at its maximum. However, when demand decreases, where the demand curve shifts to the left, the total revenue would also decrease.
With lower profits, oil producers would have fewer funds to cover up the cost and losses. Figure 4: Figure 4 shows the total revenue when market is at equilibrium and the total revenue when demand decreases. Before demand falls, the total revenue consists of the area "A+B+C+D+E+F." However, when demand declines, price of oil had dropped and it decreases the quantity supplied. The decrease in demand had caused the total revenue to slide to area "E+F." As a result of a decrease in demand, the total revenue lessens by area "A+B+C+D." As a conclusion, when the quantity demanded of oil decreases, it causes the price of oil in the market price to crumble. With effect to this, many oil producers would have to limit its exports to other countries.
If exportation continues, it would bring less revenues and more loss to the OPEC countries. Furthermore, the decrease in the price of oil could cause the production to decrease its quantity supplied and thus, it would increase the rate of unemployment. Due to this, OPEC had decreases the quantity supplied to increase the oil price in the market.