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How Changes in Supply and Demand Affect Oil Prices?

According to Boul & Anderson (2005), increase in demand for oil increases oil prices; the increase can be as a result of rapid growth in the economy. Countries such as china have been experiencing an increase in its economy, and this increase has translated to increase of locomotives and other machineries which require oil. The increase has caused an increase in demand of oil, thus contributing to the increase in world oil prices. On the other hand, a decrease in oil demand leads to a reduction in oil prices; when less oil is demanded, its supply exceeds the demand, thereby reducing the prices of oil (Musgrave and Kacapyr, 2006).

Increase in supply of oil decreases oil prices; in this case, the supply of oil is more than what is demand (Musgrave and Kacapyr, 2006). This can be caused by use of oil substitutes, deteriorating economy, among other factor. However, a decrease in oil supply increases oil prices; the decrease can be caused by war, for instance, the war in Iraq caused political unrest and in security, which greatly affected Iraq’s ability to produce oil in large amounts as it were in the pre-war times; this led to the increase in oil prices.

Baumol and Alan (2011) state that factors causing changes in demand and supply of oil in the USA include the various hurricanes in Florida and other states located in the south, which destroyed oil facilities. In addition, the frequent shutdown of refineries for maintenance, regulatory purposes among other reasons, led to a decrease in oil supply, which in turn caused an increase in prices of oil.

The two largest consumers of petroleum products

The two largest consumers of petroleum products are USA and China; whereby China is second to USA. China contributes about forty percent of oil demand growth of the world for the last four years and consumes about 5.6 million tonnes of oil each day. The above amount is estimated to grow to 12.8 million barrels per day by 2025 with net imports of 9.4 million barrels per day, as per the Energy Information Administration (EIA) Forecasts. The Unites States consumed about 20 million barrels of oil per day in 2003 (Boul & Anderson, 2005).

Explanation to what happens to price and quantity of oil when the following happens

The price of SUVs falls

SUVs are Sport Utility Vehicles; these vehicles consume a lot of fuel because of their inefficient energy utilization. According to Musgrave and Kacapyr (2006), when the price of SUVs falls, demand of SUVs will increase. This will consequently increase quantity of oil demanded, leading to a shift of the demand curve to the right. A rise in quantity demanded will cause an increase in price of oil to reduce demand and hence bring the equilibrium level back to normal. This is because SUVs will increase the consumption of fuel, and they are not energy efficient, therefore, a fall in price of SUVs increases demand of oil demanded, and hence increases in oil prices. The oil consumption can only be reduced by increasing prices of SUVs; this discourages people from buying SUVS, and encouraging them to buy energy saving vehicles, which do not consume a lot of fuel (Boul and Anderson, 2005). By doing this, demand for SUVs will decline, making supply of oil to meet its demand, and hence the oil prices will remain constant or even lower.

The government approves more drilling in Alaska

Vandermey et al (2009) argue that if the government approves more drilling in Alaska, this will have little or no impact on both price and quantity of oil demanded. This is because oil produced from Alaska is too little to bring any effect on the world oil demand. For example in US oil consumed from Alaska is used to reduce the oil deficiency caused by the decline in oil producing areas.

On the other hand, approving oil fields in Alaska will reduce dependency on petroleum imports from Latin America and Middle East. This will also increase American oil producing companies’ revenues, increase federal, local and state tax revenues and reduce the trade deficit. In addition, Alaska’s Northern slope may maintain large amounts of oil, but this is not certain since exploration is banned by Arctic National Wildlife Refuge (ANWR). There would also be big amounts of reserves for petrol in the rest of the parts in Alaska; according to the study carried out1980, around 1.69 to 14.77 billion barrels of oil may be recovered and protected at the ANWR (Gallup and Newport, 2005). This implies that there will be a little shift in demand and supply curve, which would cause a small change in oil prices. The graph shows an elastic demand. The demand curve is almost flat. In the supply curve, a drop in supply from S to S1 results to a small increase in price from p0 to p1 (Gallup and Newport, 2005). The graph also shows that the demand for oil also reduces with the shift of the supply curve.

Demand for oil also reduces with the shift of the supply curve
Demand for oil also reduces with the shift of the supply curve

Considering a product like Gasoline and why or why I would not prefer price control to pay less than the current price at the pump

Considering a product like gasoline, which has oil as a constituent, and oil is a scarce commodity, price control to pay less at the pump is not a good. If prices are controlled, people will use gasoline inefficiently or in the normal way without control, and in case o shortages in its supply the demand will remain the same, worsening the situation. Prices are important in regulating the economy; this means that they help in controlling the usage of scarce resources (Baumol and Alan, 2011). For instance, when gasoline is scarce, prices will rise, and consumers will cut down on its use, which will bring the demand and supply at equilibrium; this means that the consumer will only use what he or she requires and not fall out of its supply. People may also cut down on the usage of gasoline by avoiding daily activities that consume a lot of gasoline, and this will prolong the use of the scarce gasoline (Gallup and Newport, 2005). In the case of price control, the consumer will use more than what is supplied leading to the shortage of gasoline; this means that not everyone would get the gasoline, and eventual, there might be no gasoline to buy (Krichene, 2006). It is better to pay more and have gasoline to use, than pay less today and have nothing to pay for tomorrow

References

Baumol, J. & Alan, S. (2011). Macroeconomics: Principles and Policy. Florence, KY: Cengage Learning.

Boul, J. & Anderson, R. (2005). What is driving oil prices? The regional economist. Louisiana: The Federal Reserve Bank.

Gallup, A. & Newport, F. (2005). The gallup poll:Public opinion. Lanham: Rowman & Littlefield.

Musgrave, F. & Kacapyr, E. (2006). How to prepare for the Microeconomics/Macroeconomics. New York: Barron’s Educational Series.

Krichene, N. (2006). World crude oil Market. Tripoli: International Monetary Fund.

Vandermey, R. et al. (2009). The college writer: A guide to thinking, writing and researching. Florence, KY: Cengage Learning.