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ib economics hl notes
IB ECONOMICS HL

Internal Assessment Supply and Demand Curve on Oil

UPDATED ON - 27 APR 2020
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This Economics HL IA revolves around an article that talks about the supply and demand curve of oil. It also tells us how the SD Diagram on oil changes from country to country.

“Oil Importers Losing Faith in Russia”

 

This article centers around the ideas behind the supply and demand of oil. The article states that “with the rising demand for oil, experts suggest a significant shortage in supply of
oil”. Demand is the amount of some good or service, which an individual household consumer is willing and able to buy per period of time. In this case, although “raw” oil itself is not directly consumed by households, its byproducts such as petrol are. Certainly, throughout time, the quantity demanded oil has grown. Supply can be described as the quantity producers are willing and able to sell at a given price. In the case of oil, the supply curve (in an SD diagram) will be nearly vertical due to the fact that there is a fixed amount of oil available, in the short run. Short-run refers to the period of time in which the quantity of at least one input is fixed and the quantities of the other inputs can be varied (until greater supplies of oil are “discovered”). Furthermore, we can also conclude that the supply of oil should be price inelastic (a large change in price would trigger a small change in QD –diag1. Price elasticity refers to the responsiveness of QD/QS to changes in price.

 

The article goes to mention perhaps why oil prices are at their highest (around $70 dollars a barrel). The article lists the nuclear conflict, bad weather, and a significant oil shortage coming from Nigeria (another big oil exporter). All of these reasons are related to economic theory as they would all shift the supply curve leftwards. The article refers to the fact that Russia’s growth of oil output will be less than previously expected, partly due to unusually cold winters in Siberia (where most of the oil is found), thus slowing excavation and cutting supply. The breakup of two large oil producers, Sibneft and Yukos, also cost the Russian oil supply. Referring back to supply and demand diagram, if world demand rises from 84.8 million barrels a day to 85.1 million barrels of oil a day, and supply is to be 0.3 – 0.4 lower than expected (in Russia’s case as much as 3% lower than expected) it can be seen in Diag2 why oil prices would tend to rise. Supply shifts from S1 to S2 and demand from D1 to D2, as a result, the equilibrium price would move from EQ1 to EQ2 (equilibrium means a state of equality between demand and supply).

 

 

The author has at times overlooked the fact that as oil prices go up, some importers could be looking for substitutes. Currently, the UK is considering increasing dependence on nuclear energy mainly due to the rising cost of oil – if alternative substitutes are cheap compared to oil, then the demand for oil could drop, represented by a shift to the right (also the more close substitutes available, the more price elastic demand will be). Importing countries could research in alternatives because oil has become such an important primary commodity (materials in their raw/unprocessed state). Plastic, motor, and many other industries rely heavily on the price of oil. The author unambiguously assumes that demand will keep rising because of the price does rise by so much, there should be a fall in quantity demanded, and alternatives will become more viable. Also, the author fails to mention who gains and who loses from these higher oil prices. Higher oil prices hurt consumers but producers/suppliers gain, so even though it still may be economically optimal, it can be argued that it's inequitable since oil is a commodity and people should get its benefits at a reasonable price (the market mechanism may be working but redistribution of profits could perhaps result in greater equity in the society as a whole).

 

Although the author is correct to recognize the effect of depleting oil supplies, he has omitted the idea that technological advances and developments could lead to easier excavation of oil, not to mention the discovery of new reserves (both would increase supply). Moreover, the article comes from a Russian business newspaper owned by oil tycoon Boris Berezovsky, who also has strong links to the government and which is why one should question Russia’s pessimistic claims about future oil supply.

 

In general, it is hard enough to foresee future demand or supply figures but nonetheless the author provides a good summary of the current situation with regards to the oil market.

 

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