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Strategies & Market Trends : Booms, Busts, and Recoveries

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To: Moominoid who wrote (67317)	8/12/2005 10:24:14 AM
From: shades	Read Replies (1) of 74559

Krugmans oil supply demand curves are very different than what I saw in college econ classes. Multiple points of equilibria. dickinson.edu The Theory: Modeled after the publications of Cremer and Salehi-Isfahani in 1989 Oil is different from most commodities for the following reasons: It's an exhaustable resource National governments control its production For the biggest oil expoerters, it's a dominant source of national income What these differences mean: Because it's an exhaustabile resource not extracting it makes it a form of investment. When oil prices are high it may look like a good investment for a national government. If this government does not want to spend all the money it's receiving from these high oil prices it has one of three options: engage in real investments at home = diminishing returns invest abroad cut oil extractions and reduce supply There is good reason to believe that there are some high oil prices that lower output. This implies a backward bending supply curve. Backward Bending Supply Curve Caused by future price expectations These expecations cause one to consider the opportunity costs of oil If a price increase is expected to last for a while then the opportunity cost of selling a barrel today increases because the price of the oil is going to rise. This may cause the oil companies to save their oil and sell it later. This would create a negatively sloped supply curve. If a price increase is expected to last for a short time then the opportunity cost of selling a barrel today is not going to increase. This would create a normal positively sloped supply curve. Demand for oil is highly inelastic. This is what the graph would look like: As is evidenced by this graph there are multiple points of equilibria High Price Equilibrium(PH) This price is stable because it falls along the upward sloping portion of the demand curve. This represents the price of oil in the beginning of 1973. There is no excess supply at this high price so OPEC doesn't have a role in output control, but creates the expectations of future prices. Middle Price Equilibrium(middle) This price is unstable because it falls along the negatively sloped part of the demand curve. Low Price Equilibrium(PL) This price is stable because it falls along the upward sloping portion of the demand curve. This represents the price that OPEC picked in December of 1973. How This Explains Sudden Oil Prices Surges: The changes in the price of oil come suddenly and unexpectedly This would not happen with Cartel that is "gradually learning about its market power" This would happen if unexpected events "tipped" the market from the high equilibrium to the low eqilibrium and vice-versa

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