Analysis Of Crude Oil Price And Demand In 2015

Changes in Crude Oil Price and Demand in 2015

we see changes in price of oil for the period – March 2014 – Sep 2015. The trend line drawn hints at falling prices. This drop is more pronounced after June 2015. Before this month demand rose and fell in selected months. Demand fell to a low of -2.5%, but it rose after that. The growth in 2013-14 was lower, but it rebound after that. Demand has not fallen since 2009 as there is no negative Between 2014 and 2015 demand shows an upturn – it shows a rise in 2015.   

Both graphs use different time periods and units for analysis, (it is annual demand but monthly prices)but we can see that in 2015 price of crude oil has reduced and its demand increased. This negative movement between oil price and its demand, qualifies oil as a ‘normal good’ defined in terms of the Law of Demand. The Law  (Ponnuswamy, n.d.) ‘expresses a relationship between the quantity demanded and its price’. It puts forward an inverse relation between price and quantity demanded of a good, assuming all other determinants of demand are constant. (or ceteris paribus)

By definition, price elasticity ‘measures the sensitivity of the quantity demanded to changes in the price’  (Econ.ohio-state.edu, n.d.). It is estimated with different methods-expenditure method, graphical method, derivative method, and  % method. The method employed depends on data given- in this case we use the percentage method.

Price elasticity of demand = % change in demand/ % change in price of good.

Price elasticity = +2/-30=-1/15 = -0.06

As the value is < 1 , this is INELASTIC demand.

The source statement says demand is ‘responsive’, which tell us that demand responds, but it is silent on ‘how’ it responds. The source gives us a qualitative statement, but no quantification of the response. A ‘quantified’ response would tell us the type of elasticity we are dealing with. Assuming a normal good so that price elasticity of demand is negative, we can have the range for value from zero to infinity. 

From our calculations we get .06m, which is close to zero, making demand very inelastic. Demand is responsive but very weakly. 

The diagram shows the effect of change in prices on quantity. Since revenue is the product of price and quantity we can see the total effect of on revenue diagrammatically. A minus means a fall while plus means gain.

Economic Theory Behind the Relationship of Price and Demand

Case1: If we have elastic demand, the + in quantity will be greater than the – in price, leading to higher revenues.

Case 2: Now the + area is lesser than – area, so that loss in price is greater than gain in quantity. This inelastic demand causes revenues to fall.

Case 3: the + area equals – area- demand is The last case is when gain equals loss- demand is unitary or -1.

We have shown the cases where price fell. It can be shown for a price rise as well. The results show that for elastic demand, price and revenues are inversely related, while inelastic demand corresponds to positive relation between price and revenues.

With reference to our case, demand is inelastic so that any price rise will lead to rise in revenues.  The recommendation is –INCREASE prices.  (Setiyadi, n.d.) 

Supply elasticity (Aggarwal, n.d.) is conceptually the same as price elasticity of demand, as it measures  except that it has a positive sign as supply rises with any price rise.  (Staffwww.fullcoll,edu, n.d.)

The graph shows an increase in shale oil extraction over the years. Assuming this is a substitute of crude oil,   the total supply of energy sources (oil) has risen.  This makes supply elasticity more elastic and responsive due to more supply sources. 

The pie chart reveals 80% share to Coles and Woolworths( 37+43 = 80) of food retail sector. Smaller firms like IGA and Aldi take up the remaining share. If we include IGA then the 3 firms control 95% share of the market. This kind of market share distribution makes food retail an OLIGOPOLY.  (Econ.ohio-state.edu, n.d.)We can point out specific facts to support our statement:

1. A ‘handful’ number of firms (3 to be exact) dominate 95% of the market.
2. These 3 firms sell similar, but not identical items. S they are all retail chains, they sell a range of goods including food items, which is the focus area in the question.
3. The impending price war hints at independence of firms. If one of them slashes prices, there are fears of similar action from rivals. Such behavior is common in oligopoly. It is better for all if they an coordinate their prices and keep them high- al will make more profits. But the threat of price undercutting from rivals triggers one of them to actually slash prices. This triggers same reaction from rivals- all sell at low prices driving down profits and sustainability.

NO, price cutting is not sensible. A move like this will trigger price cuts from other 2 firms, and price cutting will continue till sustainability is threatened. This ‘race to the bottom’ is ill-advised.  Lower prices lead to lower revenues and reduced profits, with no scope to stop the slashing. The firm that does not slash prices will lose customers to the rival that slashed prices. Eventually only the firm with deepest pockets will survive, making it an eventual monopoly.

While customers benefit from price slashing, they will suffer the monopoly power when only 1 firm remains. This firm will then raise prices again to improve profits. In long run, consumers and economy suffer.

Game theory  (Levine, n.d.) offers a better option. A better strategy is for both firms to keep prices high, trusting each other implicitly that the rival will not increase price. If this trust is built then they will benefit. If there is no trust then each one ends us slashing prices till they make zero profits.

Calculating the Price Elasticity of Demand

In the simplest game  (Stengel, 2001) each firm has 2 options- keep a high price and keep a low price. The optimal solution for society and firms is to keep high prices. If the strategy if different for firms ( high price for firm 1 and low price for 2 or vice versa) then only 1 firm ends up with profits at the cost of rival firm. If both keep low prices they get equal low profits- an inoptimal solution. Though the first option 1 is best for firms there is no formal way to ‘promise’ high prices to each other. Lack of trust can start a price war if one firm undercuts. A tacit collusion/ public statements regarding price policy/ prior experience can keep in developing trust. In our case the retails chains can respond to farmers request and publicly resolve to not drop prices.

Vegetable sellers are in a MONOPOLISTIC COMPETITION  (Tutor2u.net, n.d.)structure. This is clear from the lack of power over prices of their produce. This lack of power pushes them to make an association which can speak for them collectively and have makes them  They are ‘price takers’ in the sense that they cant bargain with retail chains who are their buyers at individual level. Collective bargaining  as hinted in their association statement is their only recourse. This lack of power is supported by the stated number of sellers- 136800 sales farms.

Using the framework for a MONOPOLISTICALLY competitive firm, we show a typical farmer’s cost curves and short run equilibrium below. Equilibrium demands MR= MC so that we have price = P1, where profits are mad. These are abnormal profits as we are in short run.

If prices are slashed by retail chains they will lower the price they give to farmers as well. This reduction nin price can be sustained till we reach P2, where only normal profits are made as P2= AC. Any further price fall will cause losses and an eventual exit of the farmer from business. This is exactly what the farmers’ fear. A price war among retail chains will lower prices to such low levels that sustainability of farmers will be in doubt. 

Using the same framework, let us see if technical improvements can save farmers.  As the technology is an ‘improvement’ it will lead to lower costs. Reduced costs shift the AC and MC curves down as denoted by new AC and new MC. MR and AR does not change.  

The new equilibrium is at new E where MR= new MC. The new P is higher just like the new Q. Profits are shown in yellow. The farmers benefit from new technology as they can make profits again. 

Aggarwal, P., n.d. Supply elasticity of demand. [Online] Available at:   HYPERLINK “https://www.intelligenteconomist.com/price-elasticity-of-supply-pes/”   https://www.intelligenteconomist.com/price-elasticity-of-supply-pes/  [Accessed 7 June 2017].

Econ.ohio-state.edu, n.d. Elasticity. [Online] Available at:   HYPERLINK “https://www.econ.ohio-state.edu/jpeck/H200/EconH200L5.pdf”   https://www.econ.ohio-state.edu/jpeck/H200/EconH200L5.pdf  [Accessed 30 May 2017].

econ.ohio-state.edu, n.d. Oligopoly. [Online] Available at:   HYPERLINK “https://www.econ.ohio-state.edu/jpeck/H200/EconH200L13.pdf”   https://www.econ.ohio-state.edu/jpeck/H200/EconH200L13.pdf  [Accessed 8 June 2017].

Levine, D.K., n.d. What is game theory. [Online] Available at:   HYPERLINK “https://levine.sscnet.ucla.edu/general/whatis.htm”   https://levine.sscnet.ucla.edu/general/whatis.htm  [Accessed 7 June 2017].

Ponnuswamy, S., n.d. What does law of demand state? [Online] Available at:   HYPERLINK “https://owlcation.com/social-sciences/What-does-Law-of-Demand-State-And-What-are-the-Exceptions-to-the-Law-of-Demand”   https://owlcation.com/social-sciences/What-does-Law-of-Demand-State-And-What-are-the-Exceptions-to-the-Law-of-Demand  [Accessed 4 June 2017].

Setiyadi, D., n.d. Relationship between price elasticity and total revenue. [Online] Available at:   HYPERLINK “https://www.academia.edu/7378448/The_Relationship_Between_Price_Elasticity_of_Demand_and_Total_Revenue”   https://www.academia.edu/7378448/The_Relationship_Between_Price_Elasticity_of_Demand_and_Total_Revenue  [Accessed 4 June 2017].

Staffwww.fullcoll,edu, n.d. Price elasticity of supply. [Online] Available at:   HYPERLINK “https://staffwww.fullcoll.edu/fchan/Micro/2price_elasticity_of_supply.htm”   https://staffwww.fullcoll.edu/fchan/Micro/2price_elasticity_of_supply.htm  [Accessed 4 June 2017].

Stengel, T.L.t.a.B.v., 2001. Game theory. [Online] Available at:   HYPERLINK “https://www.cdam.lse.ac.uk/Reports/Files/cdam-2001-09.pdf”   https://www.cdam.lse.ac.uk/Reports/Files/cdam-2001-09.pdf  [Accessed 7 June 2017].

Tutor2u.net, n.d. Monopolistic competition. [Online] Available at:   HYPERLINK “https://www.tutor2u.net/economics/reference/monopolistic-competition”   https://www.tutor2u.net/economics/reference/monopolistic-competition  [Accessed 4 June 2017].

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