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A Microeconomic Analysis Of The Oil

As one branch of economics, Microeconomics focuses upon the problems of decision-making within confined resources allocated. (Bade, 2001) Microeconomics, sometimes known as Price Theory, depend its research objective on the individual or active market single unit and analyze the potential method in maximizing profit and utility via rational and effective distribution of limited resources. The contents of microeconomics comprise a variety of theories such as consumers’ behaviors theory, producers’ behaviors theory, equilibrium theory and allocation theory. (Arrigo, 2009) It derives the deduction from the basic concept of resources scarcity and seeks the manners and other pertinent conditions in maximization of personal earnings. Microeconomics serves to make clear the relationship between operational decisions and behaviors. The resolution is to resort to the understanding of the mutual reaction of supply and demand of specific goods or services and the corresponding change of prices and its reversal effect on the provision and requirement trends. The primary aim of microeconomics lies upon the comprehension of the market change and how the factors within the system react with each other in order to form a dynamic equilibrium. It analyzes the cradle of market failure, accessibility of confined resources and offers the theoretical foundations for the consideration of efficient market and perfect market. Currently, major concerns of microeconomics include risk measurement, market efficiency, and the elasticity. This report will firstly provide some introductory information about the theories of microeconomics. Secondly, it will cite a realistic situation to demonstrate how these theories work and corresponding explanations. Finally, a conclusion will be rendered.

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2.0 Theoretical Basis

The microeconomics is expanded via some fundamental assumptions. These conditions may seem to be rational, but in reality some deviations are also permitted. The forerunning premise is the existence of perfect competition which indicates that there are numerous trading objects and prices are independent from the intervention of any individual within the market system. However, as a matter of fact, this condition may be vulnerable to external manipulations exerted by some individuals or groups. Another assumption lies upon the fact of resources scarcity and rational trading objects. This assumption wipes off any unnecessary and irrational behaviors exhibited such as sponsorship or other forms of gratuitous donation. Supply and demand model plays the function in predicting prices of goods or services. In one competitive market, price will be a repercussion of the product quantity change. The equilibrium can be achieved at specific position. As one partial model, the price and quantity possess reciprocal effect on each other. The variables of the supply and demand curve are conducted the simple shift from one position to another. The utility maximization is constructed through various mixtures of goods or services, it should be mentioned that the curve does not directly manifest any consumptions’ earnings. The comprehensive curve of supply and demand suggested possible outline of specific individual decisions and tendencies on the premises of constrained economic conditions. (B Lewins, 2004)

Price elasticity of demand is another measurement used in the supply and demand curve; it calibrates the reaction degree of quantity demand toward price changing. It exhibits how the quantity of goods or services is impacted by the price variations. (VL Smith, 1982) Typically, it is useful to measure the offsetting degree of price increase toward demand reduction. Elasticity is quantified as the percentage change of sales divided by that of price change.

3.0 Case Citation

In current oil market, there always exist the question what drives price high and low. Demand and supply relationship in market is mathematically depicted by the price, quantity and other relative information. In this article, it explains the major reason for the oil price change is the change of demand. According to the data from 2003 to 2006, the price remains to be equivalent for the relatively stable supply and demand relationship. However, since 2007, the demand grows as some developing countries’ increasing requirement for raw materials and resources. The article lists out the supply and demand data in various countries within recent years. It can be seen from the data list that the supply keeps a growing trend from 2003 to 2007, among the providers of oil; non-OPEC occupies a large proportion of gross provision. The increasing scale reaches greatest in first few years since 2003; the supply from 2005 to 2006 maintains a relative stable level. As for the aspect of total demand, it keeps a similar pace with supply from 2003 to 2006; the deviation is not very outstanding. Since 2007, the demand surpasses the supply. As predicted by the IEA, the global demand for crude will be average 86.6mbpd in 2010. On the other hand, the total output of supply is expected to be still under the gross demand in 2010 and 2011 respectively. Given the gap between consumption of refined oil products and raw material provision in 2008 first quarter, the increasing scale is approximately 16.5 percent, it can be predicted the deviation will be widened in the foreseeable future.

Figure 1 the relationship between supply and demand from 2003 to 2007

In accordance with the realistic data, the curve for price and quantity can be described as fig 2. The diagram properly manifests the price and quantity stability. Under the equilibrium situation, the price and quantity maintain to be less vulnerable to external changes.

Figure 2 Supply and Demand Curve of oil for equilibrium status

So as the demand increases and the production remains limited, the price will change to another level. For oil market, the original equilibrium point is at A, with a fixed price and quantity level. After a strong promotion of demand, the curve shift to the point C, however, the capacity of raw oil production reaches only about very small proportion in contrast with demand. So a new equilibrium is constructed as point D. At this point, the price and quantity both increase; the primary genesis for the fluctuation price is the fettered ability in increasing oil provisions. For oil, it cannot be perorated that oil is inelastic, for the reason that the price reacted well to the quantity demanded.

Figure 3 Supply and Demand Curve of soybean

However, if the supply and demand keeps a identical growth scope, namely, the demand grows as the supply grows, the curve will also reach for a new spot, at this spot, the price remains unchanged, just as the same did from 2003 and 2006. At the point D, the price remains to be stable, though the quantity increases.

Figure 4 Predicted supply and demand curve for identical increasing capacity

4.0 Conclusion

The supply and demand model, accompanied by other basic hypothesis and premises, serves the fundamental explanation for understanding of microeconomics. In a sense, microeconomics analyzes the potential commercial behaviors of both buyer and seller. Just as the article mentioned above, oil price reacts to the quantity demand and produced. Aside from some simple cases, the theory also works well for some other kinds of cargos or goods such as agricultural products. In actual cases, practical events or other experiences echo the microeconomic theory in a proper way. It extends its deduction from the consumer and seller sides. The following conclusions are correlated and depended. It offers a discrepant viewpoint toward the world around people and enhances personal insight and efficiency-balancing ability. Albeit the universal property of microeconomics, there are other factors that also inflict important impact upon the oil markets such as depreciation of USD, other financial support which tends to raise the price and global ongoing concern over alternative energy resources.

5.0 Refs

Bade, Robin; Michael Parkin, 2001. Foundations of Microeconomics. Addison Wesley Paperback 1st Edition)

Arrigo Opocher; Ian Steedman, 2009. Input Price-Input Quantity Relations and the Numeraire”, Cambridge Journal of Economics, V. 3: p937-p948

B Lewin, D Giovannucci and P Varangis, 2004. Coffee markets: New paradigms in global supply and demand. World Bank Agriculture and Rural Development Discussion Paper No. 3.

VL Smith, 1982. Microeconomic systems as an experimental science, The American Economic Review, JSTOR.


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