Should Government Try To Solve Shortages of Oil?

Should the Government intervene to deal with problem of Oil Shortages or is it better to leave it to a free market?

As oil runs out, supply will shift to the left and the price will increase. Because demand is inelastic, oil firms will make increased profits. This creates an incentive for oil companies to discover new oil supplies. This research is often expensive, so the higher profits is beneficial for encouraging investment. There are many oil reserves which are difficult to access, e.g. oil in the Antarctic and Siberia. Therefore, the cost of production may be $100 a barrel. Therefore, now oil prices have risen over $100, it has become profitable. Therefore, the market can respond to the changing market signals and try and increase supply. Also, firms have an incentive to develop and promote alternatives to oil, such as solar panel cars; the more expensive oil becomes the more attractive these options are.

In theory, the free markets should respond to shortages and rising prices through increasing supply or developing alternatives. However, the free market may not be able to deal with the oil shortages in a timely manner.

Firstly, demand is rising very rapidly because of economic expansion in Asia (China and India). Therefore, prices are rising rapidly, even though supply is still increasing. If we had a combination of falling supply and rising demand, prices could skyrocket. Investing in new supplies or alternatives to oil could take several years. By the time the free market has provided alternatives to oil, the world economy may have suffered several years of very high oil prices.

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Inelastic demand

Demand is price inelastic when a change in price causes a smaller percentage change in demand. It occurs where there is a PED of less than one.

For example, if the price of cigarettes rises 10%, and there is a 2% fall in demand, the PED = -0.2

inelastic-demand

In the above case, the price of a good falls 30%, demand  increases 10%  the PED = - 0.33

Examples of inelastic demand

  • Petrol
  • Cigarettes
  • Salt
  • Chocolate
  • Goods where firms have monopoly power

Factors that make demand inelastic

  • No substitutes. If you have a car, there is no alternative but to buy petrol to fill up the car. If you rely on the train to get to work, the train firm can increase prices with little fall in demand.
  • Little competition. If a firm has monopoly power then it is able to charge higher prices. For example, prices on motorway service stations tend to be higher, because consumers can’t choose where to buy food, without leaving the motorway.
  • Bought infrequently. If you buy a good infrequently, such as salt, you are less likely to be sensitive to price.
  • Small percentage of income. If you a good like salt is a small percentage of income, you may be less concerned about price.

Impact of Tax

supply-demand

A tax will shift the supply curve to the left, leading to a higher price and a fall in demand.

If demand is inelastic, then the tax will have the effect of raising the price significantly and reducing quantity only slightly. This will help to increase tax revenue for the government. Cigarettes tend to have inelastic demand; when the government increases tax, firms are usually able to pass the whole increase onto consumers.

Example – effect of tax on cigarettes

Price elastic demand

If demand is price elastic – an increase in price causes a bigger % fall in demand.

producer-burder-consumer-burden-2

If demand is elastic. It means consumers are more sensitive to changes in prices. Therefore, an increase in tax will cause a big fall in demand, and price will rise only slightly. Therefore, the government will see a fall in tax revenue. Also, if demand is price elastic, the consumer burden will be smaller than if demand is inelastic.

 

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UK Housing Market and the Euro

Readers Question: ‘Outline two reasons why the UK’s housing market represents a barrier to the UK’s membership of the euro’.

Joining the Euro involves a common monetary policy. This means that UK interest rates will be set by the ECB. Therefore, if the ECB have to increase interest rates it will increase UK rates and therefore increase the cost for UK homeowners. If interest rates increase at the wrong time it could cause economic hardship for homeowners.

1. Mortgages are a high % of consumer’s disposable income and therefore are sensitive to changes in interest rates. UK House prices are a high ratio of average incomes. Many homeowners have had to take out mortgages 4-5 average incomes to get on the property ladder. This means mortgage payments are a high % of disposable income. If interest rates increase, it could make mortgages unaffordable. Continue Reading →

Economic Way of Thinking

Readers Question: Nice blog…i have a question..how can i outline the major elements of the economic way of thinking?..

Interesting Question. Firstly, Check out this essay: Economics – The Dismal Science.

See also: Difference Between Economists and non Economists

You may also be interested in a book like this – The economic Naturalist

Economics is concerned with the optimal distribution of scarce resources. Therefore economists are concerned with:

  • Market forces – supply and demand. What determines prices?
  • Rational behaviour. Most economic theory starts off with the assumption
  • Opportunity Cost. – What is next best alternative of using those particular goods or buying that item?
  • Efficiency – what is optimal way of producing and distributing goods.
  • Cost Benefit Analysis. – Do the benefits of this project outweight disadvantages. For example, pollution may be bad. But, economists will be concerned at arriving at an optimal level of pollution which takes into account all social benefits and social costs.
  • Evaluating the relative importance of wealth vs inequality. What is best way to increase economic welfare.

Mathematical Models

Where possible, economists will try to model the behaviour. The aim is to find patterns and use this to predict likely outcomes. In the real world, it is often difficult to model behaviour because there are so many different variables.

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Male Inactivity Rates in UK

Readers Question ‘Evaluate two policies which the government might adopt to reduce the male inactivity rate’

Main Reasons for Inactivity in Labour Market

Inactivity rates implies that people have left the labour market and are not able or are unwilling to seek employment. According to the ONS, inactivity rates can be caused by:

  • Being a student
  • Looking after family / home
  • temporary sickness
  • long-term sickness
  • Discouraged
  • Retired (early)
  • Other
economic activity
Source: ONS (nov, 2011)

Policies To Reduce Inactivity Rates

1. Make It more difficult to gain sickness / long term disability benefits. It is argued that it has become too easy for the long term unemployed to be given sickness benefits. The government could introduce a scheme where those on benefits are revaluated every 12 months and given the option to take on light work. This could help reintegrate them into the labour market. Continue Reading →

Forecast for the Euro in 2008 and beyond

It is easy to forget, but, only 5 years ago people were talking about the Euro as if it was doomed to fail. 1 Euro got you 86 cents. 5 years later and 1 Euro is worth $1.48 and people are suggesting the Euro is set to be the next global reserve currency.

The Euro’s strength is mainly a reflection of the dollars weakness.

US interest rates have fallen due to the threat of a recession in the US. This fall in interest rates, relative to the EU means the Euro has become more attractive as a place to deposit ‘hot money flows’

Also, unlike the US, the Euroarea has broadly equilibrium on its current account. Quite an achievement given the strength of the Euro.

In 2008, US interest rates have continued to fall, to try and negate the effects of the housing crisis. This could maintain the weakness of the Euro. However, the EU economy is showing signs of strain under the decline in export competitiveness. If growth in the EU slows, the ECB may follow the example of US and cut Euro interest rates. This would change the market dynamics significantly. The short term strength of the Euro may decline (much to the delight of EU manufacturers)

Long Term Forecast for Euro

The EU economy has been doing better in the past couple of years. But, there are real problems lurking in the shadows.

The Alternative to the Dollar.

Some people, who would like to see America go down in the world, have been taking great delight in the free falling currency. If the dollar continues to slide investors and holders of foreign currency may feel inclined to switch out of investing in dollars, but prefer the more stable Euro. This may also encourage people to hold reserves in Euros rather than dollars. If the Dollar does lose its position as most trusted currency, it will be harder for America to borrow at cheap interest rates.

Ageing Population

Europe has an ageing population and inverted population pyramid. Furthermore European governments are tied to generous welfare benefits for the retired. European governments face a real crunch – How to finance its growing pension bill from a diminishing workforce. The problem is more acute in Europe than America. It could cause slower long term growth in Europe.

Definition Research & Development and Innovation

Readers Question: It’s not a good question, but i’ll ask it. Could you explain differences between Research and Development and innovation?

Research and Development involves investment in discovering new technology and increasing capacity of a firm. It could involve technological innovation or improvements in human capital. It usually requires a willingness to forego current profit to invest. Successful research & Development may lead to innovate new products. There is no guarantee that Research & Development will be successful. You could spend Billions of pounds in researching an alternative to oil, but, it may fail.

Innovation. Innovation involves improving the method of working / producing goods. Often it will involve better technology or better methods of working. Innovation may be the result of Research & Development. But innovation could also be a ‘brainwave’ – A Eureka moment where someone has a good idea to improve working practices.

So they are quite similar. One difference is that innovation, may not require any investment of time or money.

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Revision Tips for A Level Exams

In the UK, it is currently the exam season and my students are finally thinking of doing some actual revision. These are some tips to make your revision more effective.

Learning is Active Not Passive.

if you just read a textbook from start to finish, you will struggle to learn much. Active revision means that you are constantly thinking and trying to understand the concepts involved. This is the key to successful revision. Every 15 minutes, ask yourself what have I actually learnt? Don’t measure your revision by time spent, but amount of things learnt.

Work Out The Questions That May Appear in Exam.

The most important step in revision is to know the kinds of questions that may appear in the exam. It is insufficient to just know the topics. You need to think about the kinds of questions that might appear. It is essential to get hold of past papers. Make a list of common questions and try to think of possible variations. For example, if last year you had a question. “Discuss impact of interest rates on Exchange Rates.” maybe this year will be “Discuss impact of interest rates on inflation and Balance of Payments.” See: A Level Past Papers

Test Yourself.

Make a list of things you need to learn and questions that might appear. Then close all your books. What can you remember? Make a list of what you know and then when you are stuck, check up on what you missed and make a point of trying to remember these.

Understand The Mark Scheme.

A level exams are not just about knowledge and memorising facts. There is a high weighting (up to 40%) for evaluation. This means the ability to critically examine the material you present – looking at issues from different aspects and angles.

  • See tips for writing evaluative essays
  • Using Data Responses: It is important that if you answering a data response, you actually make use of the date they give you. It may seem an obvious thing to say, but, many people forget about it. This shows that exam technique is just as important as learning

Planning

Some people spend hours creating complicated exam timetables, but, then don’t stick to it. It is important to plan your revision, but, keep it simple and realistic.

How Long To Revise for?

4 – 5 hours of revision a day is a lot. If you are revising properly and actively learning; you will make a lot of progress in 4 hours. Also, if you have a target for 4 hours a day, it doesn’t sound that intimidating. There should also be a point in the day, when you can cut off and do something completely different. Generally, it is good to get the revision sessions done early in the day; then it won’t be on the back of your mind all day.

Revise With Other People

It can be good to revise with other people; it can also be easy to get distracted and start talking of other things. Pick  your revision partners carefully, if they are more interested in chatting and gossiping, don’t try to revise with them. However, if they are committed to learning, it can be a good way to test each other and not get so bored.

Oil Price Predictions 2008

The price of oil reached another record high yesterday – $125

  • Brent Crude oil reached $126
  • US light crude oil reached $128 before setting back to $127

This means that, even adjusted for inflation, oil is now close to the all time high, last reached in the 1970s.

What are the reasons behind the Recent Increase in price of oil?

  • Strong Economic Growth. In particular growth from China and India have caused increased demand for oil and related products
  • Shortage of Supply.
  • Speculation – People have been speculating on the continued rise in price of oil. It has become an alternative to the weakening dollar.
  • Political Tensions – With the lingering threat of invasion of Iran, commentators still feel that events in the middle east could disrupt future supplies and cause higher prices.

Forecasts for the Future

Speculation or Shortage?

Some members of OPEC dispute that there is a fundamental shortage of oil. They argue that there is plentiful supply of crude oil. Therefore they argue that the recent price rises are not based on economic fundamentals, but a speculative bubble. If this is the case, oil prices could easily fall next year when market sentiment changes.

Global Growth. Some feel that the US economy is heading towards recession, because of the weakness in the housing market. However, US growth is still remarkably resilient and Global growth is being bolstered by the strong performances from the Chinese and Indian economy. With no imminent slowdown in economic growth from China, demand for oil is likely to keep rising.

The Dollar. If the dollar continues to remain weak, this will strengthen oil prices. Yesterday, the Fed said interest rates are unlikely to fall in the near future; this may help stabilise the dollar. See predictions for US dollar 2008

Related:

What Would Stop Devaluing Dollar?

Readers Question: What would stop the falling dollar?

The dollar has been falling for many reasons. These are some of the factors which would stop the dollar falling and lead to a recovery in the value of the dollar.

Higher Interest rates. US interest rates have been cut to 0% in an effort to stave off a US recession. This causes an outflow of hot money. If interest rates were raised it would encourage people to save in the US and cause an appreciation.

Recovery in US economy. The US fear recession because of a declining housing market, this is leading to lower interest rates and lower confidence about the US economy. If the economy recovered, interest rates would increase and people would have more confidence in buying dollars.

Fears Over the Euro. The main beneficiary of the falling dollar has been the Euro. People are increasingly seeing the Euro as an alternative reserve currency to the dollar. Therefore, investors have been switching out of the Dollar. However, confidence in the Euro may be misplaced. The Euro economy is not much stronger than the US. Many European economies face the prospect of falling house prices; also the strength of the Euro is causing problems for exporters. Arguably, the Euro is overvalued on economic fundamentals – the dollar looks cheap on purchasing power parity. Maybe the sell off of dollars has been overdone.

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