The Supply of Oil for Central Heating - Essay Example

Question This question is concerned with the supply of oil for central heating. In each case consider if there is a movement along the supply curve (and in which direction) or a shift in it (and if left or right). In all the arguments that follow we shall view the supply of oil as an integrated world market. Our premise is based on the fact that: (1) the products of crude oils of different geographic origins are can essentially be interchanged; (2) these different crudes could easily be blended; and (3) costs of transporting oil are low. In this regard, crude oil is fungible, which means that a shortfall in one region of the world can be made up by shipping similar oil there from another region of the world (Nordhaus, 2009). This therefore implies that the price and quantity dynamics are determined by the by the total consumption of oil along with the sum of demands and supplies, and are independent of the origin country of supply or demand (Nordhaus, 2009). Case1: new oil fields start up in production Let’s take the world oil market as a giant bathtub. Taps (suppliers) add oil into the bathtub and drains (consumers) remove all from our giant bathtub. An equilibrium level of oil in our bathtub (equilibrium quantity) is maintained when the rate of inflow from the taps equals the rate of outflow from the drains. A new oil field starting production resembles the introduction of a new tap onto our bathtub. With the rate of drain remaining the same we expect the level of oil in our bathtub to go up because the previous equilibrium has been upset. When a new oil field starts up in production it increases the world’s total oil supply that will be available to consumers. This will cause the supply curve to shift outwards or to the right (from S1 to S2 in Figure 1 below). For a given demand curve this outward shift would cause the market equilibrium price to fall (From P1 to P2) and quantity demanded to correspondingly increase (from Q1 to Q2) as shown in Figure 1 below. Figure 1: Outward shift in supply (S1 to S2) Case 2: the price of gas falls Gas is a substitute for central heating oil. Assuming that the consumers’ choice on one over the other is determined by price; then a fall in the price of gas will lead to increased demand and consumption of gas at the expense of central heating oil. Supposing the suppliers continue with their normal production then the increased demand for gas over central heating oil will mean that latter will not be moving as much is was prior to the price drop in gas. Therefore, there will be more central heating oil in the market than under ordinary circumstances. Translating this effect on the central heating oil’s supply curve means it will shift outward or to the right as demonstrated by Figure 1 above. Case 3: oil companies anticipate an upsurge in the demand for central heating oil Using our earlier analogy of the oil market as a giant bathtub with taps (suppliers) and drains (consumers), an upsurge in demand would mean increased drains or drainage. This does not affect the number of taps and therefore we would expect the level of oil in the bathtub (equilibrium quantity) to go down. However, in our case the demand has not actually increased, rather it is anticipated. Nevertheless from our analogy we envision that should it happen it would affect demand and not supply. Applying this reasoning to our case, an anticipated upsurge in the demand for central heating oil will not cause the demand curve to shift to the right. This would cause an expansion to occur along the supply curve and lead to a rise in the market equilibrium quantity and price. This is favorable for the suppliers because it will enable them to sell their oil at a higher price which will earn them more revenue as shown in Figure 2 below. Figure 2: Outward shift in demand (D1 to D2) and upward movement on supply curve Case 4: the demand for petrol rises Petrol is neither a substitute nor complimentary product to central heating oil. Therefore a change in the demand for petrol should not have an effect on the demand of central heating oil. We therefore do not expect the rise in demand for petrol to immediately have an effect on the central heating oil’s supply curve. Case 5: new technology decreases the costs of oil refining With lower production costs, the oil producers would be inclined to produce more because of the increased marginal benefits that will accrue with increased production. This would increase supply in the market and thus cause the supply curve to move to the right as shown in Figure 1 (outward shift in supply) above. Case 6: all oil products become more expensive When the price of all oil products go up we expect the level of consumption to go down as consumers monitor their spending. Such a move would have an effect on the demand for oil products. The demand will go down. This means the demand curve will shift to the left or inwards. A shift in the demand curve inwards will cause a movement along the supply curve and a decrease in the market equilibrium price and quantity as shown in Figure 3 below. Firms in this instance will sell less at a lower price and therefore receive less total revenue. Figure 3: Inward shift in demand (D1 to D2) and downward movement on supply curve Compare and contrast the changes of the GDP of four OECD countries and provide some reasons behind these changes. In the Figures 1-4 below, we look at the Gross Domestic Product (GDP) of four OECD countries from different continents: the United States, Australia, Spain and South Korea. The GDP values cover three years 2008, 2009 and 2010. In the following section we shall look at the trends in GDP for these four countries and provide some possible reasons behind these changes. The United States Figure 4: Changes in the US GDP (OECD, 2011) The downward trend from 2008 to 2009 was a direct result of the financial recession. The upward trend in 2010 reflected the US economy’s response to changes in fiscal policy geared towards promoting growth. These policies led to positive contributions from increases in federal government spending, exports, personal consumption expenditures and nonresidential fixed investment (BEA, 2011). Australia Australia’s GDP continued to grow in spite of the global recession largely because of the continued high demand for its commodities in the Asia Pacific, especially from China (CIA, 2012). The country has ongoing free trade agreement negotiations with key Asian economies of China, Korea and Japan. Australia recorded the best economic growth among OECD countries in 2009. Figure 5: Changes in Australias GDP (OECD, 2011) Spain Figure 6: Changes in Spains GDP (OECD, 2011) The effects of the global economic recession hit Spain particularly hard. The domestic construction and real estate market collapsed and put excessive pressure on Spanish banks which had a high exposure to this market (CIA, 2012). Other factors behind the continued downward trend in GDP are rise in unemployment and falling consumer spending. South Korea South Korea’s growth continued even as the rest of the world was experiencing the effects of the economic recession in large part due to an expansionary fiscal policy, low interest rates and growth in exports (CIA, 2012). Figure 7: Changes in Koreas GDP (OECD, 2011) From the above graphs in Figures 1-4 we notice that the European and American OECD countries experienced the big GDP drops whereas their counterparts from Asia and Australia experienced growth. A probable cause for this general observation is each country’s exposure to the US financial market – the epicenter of the global financial crisis – and the reliance on each countries level of reliance on global trade markets. ‘A country’s GDP is quite a narrowly defined quantitative, rather than qualitative measure of country’s production of goods and services and can be quite an imprecise and misleading indicator of the economic wellbeing of the inhabitants of the country’- true or false. Justify your answer in details with some examples. It is true that the GDP can be quite an imprecise and misleading indicator of the economic wellbeing of the inhabitants of a country. For starters, GDP does not measure the effects to the environment that are a direct result of a financial transaction. This way GDP totally ignores the importance of the environment and/or environmental sustainability towards our economic wellbeing. It is a fact that humanity does need what nature provides to directly or indirectly produce goods and services in future (Global Footprint Network, 2012). So, GDP could be touted as a measure focused only on the many transactions benefiting the current economy at the expense of future growth. A second reason why GDP could be viewed as a misleading indicator of the economic wellbeing of the inhabitants of a country is that it views natural disasters and crime as economic benefits. It is obvious that when crime goes up within a locality or a natural disaster such as Hurricane Katrina strikes, the population there live in a distressed state. However, in GDP calculations an upsurge in crime leads to increased consumption of security goods and services in order to prevent crime. On the other hand, GDP calculations view natural disasters such as Hurricane Katrina as a factor that increases the demand for home repair and construction, property replacement and other activities which lead to injection of billions of dollars into economy. Thirdly, GDP only measures monetized services. This assumes that only those services that involve a financial transaction are important to the economic wellbeing of the inhabitants to a country. We know that this is not true because there are numerous important services that are done without financial transactions such as child care, elderly parental care and other similar volunteer activities. Another reason why GDP could be quite an imprecise and misleading indicator of the economic wellbeing is that it does not take into account the quality of the goods and services being consumed. GDP calculations are only interested on the total value of the transactions made. For example say the consumers in country X base their buying decisions solely on price. These consumers could be buying cheaper but sub-standard goods. In the long term they are forced to continuously buy in order to replace the cheap goods. These consumers may end up spending more money than they would have if they bought a better quality, longer lasting but more expensive good once. In this instance the GDP value would be high but then its growth will have been based on inefficiency and waste. The fifth reason why GDP could be viewed as a misleading indicator of the economic wellbeing of the inhabitants of a country is that it does not make known inequality concerns. It is generally taken that when a country’s GDP goes up, then everyone within that country benefits. This is so far from the truth. A good example is the slowly climbing GDP in the US as the economy is beginning to recover from the financial crisis of 2007/2008. This is depicted in Figure 1 above that shows changes in the United States’ GDP. We also know that the United States’ GDP in 2011 was much greater than it was 40 years ago. However, according to U.S. Census Bureau figures released on September 11, 2012 poverty in the U.S. now is almost the highest in the last 20 years (Dodge & Dorning, 2012). Furthermore, the income gap between rich and poor people has also grown to be the widest in more than 40 years (Dodge & Dorning, 2012). This goes to show how GDP clearly ignores the critical role of income distribution as a characteristic of universal wellbeing. Finally, GDP ignores the demerits of financing the economy through debt. For example the US government and Americans in general are highly indebted. Worse still, many Americans get into debt for consumption and not for investment. Living in debt is not a positive indicator of economic wellbeing. Thus the huge US GDP does not necessarily imply that Americans are living well because under the surface many people are highly indebted. -------- References BEA (2011). National Income and Product Accounts Gross Domestic Product, 4th Quarter and Annual 2010 (advance estimate). [Online]. 28 January 2011. Bureau of Economic Analysis. Available from: http://www.bea.gov/newsreleases/national/gdp/2011/gdp4q10_adv.htm. [Accessed: 14 September 2012]. CIA (2012). CIA - The World Factbook. [Online]. 2012. CIA.gov. Available from: https://www.cia.gov/library/publications/the-world-factbook/geos/br.html. [Accessed: 14 September 2012]. Dodge, C. & Dorning, M. (2012). Rich-Poor Gap Widens to Most Since 1967 as Income Falls - Bloomberg. [Online]. 12 September 2012. Bloomberg. Available from: http://www.bloomberg.com/news/2012-09-12/u-s-poverty-rate-stays-at-almost-two-decade-high-income-falls.html. [Accessed: 14 September 2012]. Global Footprint Network (2012). Footprint Basics - Overview. [Online]. 2012. Global Footprint Network. Available from: http://www.footprintnetwork.org/en/index.php/GFN/page/footprint_basics_overview/. [Accessed: 13 September 2012]. Nordhaus, W. (2009). The Economics of an Integrated World Oil Market. OECD (2011). Country statistical profiles: Key tables from OECD. [Online]. 2011. OECD iLibrary. Available from: http://www.oecd-ilibrary.org/economics/country-statistical-profile-australia_20752288-table-aus. [Accessed: 13 September 2012]. Read More