Question

1. Assume that oil begins to run out and that extraction becomes more expensive. Trace through the effects of this on the market for oil and the market for other fuels.

As oil begins to run out and the costs of extraction rise, so the supply curve will shift (upwards) to the left. With a given demand curve, the price will rise.

Over time, as prices rise, so people and firms will increasingly try to find cheaper alternatives, such as households shifting from oil-fired central heating or electricity generating companies shifting away from oil-fired power stations. People will also try to cut down their consumption of oil by using it more efficiently or more sparingly. For example, people could switch to smaller, more fuel efficient cars and invest more money in insulating their homes to save on energy. This can be illustrated by the demand curve being further to the left in the future (given a higher price) than at the present time. Firms too will have an incentive to invest in energy efficient technology. The effect of these reductions in demand will help to dampen the rise in price.

What we are talking about here is the responsiveness of demand to the higher price. In the short run, there may be little people can do. In the long run, there may be many more opportunities for using less oil. We examine the question of responsiveness of demand in the next chapter when we consider the concept of ‘elasticity’.

If reductions in demand for oil are achieved by switching to alternatives, such as solar panels or wind turbines, so the demand for these alternatives will rise. Other things being equal, the effect of this increase in demand for alternative energy sources will increase their price. If, however, there is increased investment in developing these energy sources, their costs may come down. In other words, the increased demand may be partially, wholly or more than wholly offset by a rise in supply. The new price will be where the new demand and supply curves intersect, which may be above or below the original price depending on the relative shifts in demand and supply curves.

2. This question is concerned with the supply of oil for central heating. In each case consider whether there is a movement along the supply curve (and in which direction) or a shift in it (and whether left or right).

(a) New oil fields start up in production.

(b) The demand for central heating rises.

(c) The price of gas falls.

(d) Oil companies anticipate an upsurge in demand for central heating oil.

(e) The demand for petrol rises.

(f) New technology decreases the costs of oil refining.

(g) All oil products become more expensive.

(a) Shift right.

(b) Movement up along (as a result of a rise in price).

(c) Movement down along (as a result of a fall in price resulting from a fall in demand as people switch to gas-fire central heating).

(d) Shift left (if companies want to conserve their stocks in anticipation of a price rise).

(e) Shift right (more of a good in joint supply is produced).

(f) Shift right.

(g) Movement up along.

Answer 1

1.)

If oil extraction becomes more expensive, then the following series of events will take place -

• The cost of oil extraction will increase
• The price of oil will increase because the supply curve will shift to the left
• The quantity of oil in the market reduces
• This also reduces the demand for oil because people will move to other sources of fuel
• This will result in the demand curve for oil shifting to the left too
• The initial rise in price will be offset by the shifting of the demand curve
• The resultant quantity of oil in the market will be less

2.)

(a) New oil fields start up in production - Supply curve shifts to the right as supply increases without any change in the price

(b) The demand for central heating rises - Movement will be up along the supply curve as the price increases because of the rise in the demand

(c) The price of gas falls - Movement will be down along the supply curve as the price decreases because of the fall in the demand

(d) Oil companies anticipate an upsurge in demand for central heating oil - Movement will up be along the supply curve as the price increases because of the rise in the demand

(e) The demand for petrol rises - Movement will be up along the supply curve as the price increases because of the rise in the demand

(f) New technology decreases the costs of oil refining - Supply curve shifts to the right as supply increases without any change in the price

(g) All oil products become more expensive - Movement will be down along the supply curve as the price decreases because of the fall in the demand