Question

The price of oil in international markets has dropped stunningly 60% in the past twelve months. Among the factors mentioned behind this drastic fall is the millions of barrels of oil produced in the US called shale oil.

Look at the supply and demand picture for this commodity and try to analyze its price action. Discuss the impact of price elasticity of supply and demand in the short and long terms.

Should be in 3-4  pages thanks

Answer 1

Price of oil in international markets has dropped stunningly 60% in the past twelve months. The major reason behind this fact is that millions of barrels of oil is produced in US called shale oil. As shale oil is a substituent of oil ,so cross elasticity between oil and shale oil is positive. As there is a huge supply of shale oil, the price of shale oil would be less. People would switch to shale oil and as a result other oil companies also have to reduce the price. Thus the result is that the price of oil in international market has dropped stunningly 60% in the past twelve months.

As a result of increase in supply of shale oil in international market, the supply curve shifts rightwards. Thus a new equillibrium point is reached and as a result price P2 corresponding to it would be lower than initial price P1. Thus, the price of oil falls down in the international market.

Demand of oil is relatively inelastic in the short run,ie, by making change in the price of the oil,the quantity demanded does not change much. This is due to the fact that oil is is a necessity item and consumers do not get any substituent of oil in the short run. At the same time,the supply is also relatively inelastic, as the firms incur high investment cost in setting up the manufacturing facility and it is not possible to fluctuate the supply with change in price.

But in the long run,consumers of oil look for substituents and switch from oil to other fuels which requires time period to be developed. As a result, in the long run, the demand of oil becomes relatively elastic, as other substituents are explored and thus consumers switch to alternates and thus the demand of oil falls.

Comment