Let us define "peak oil" as a point in time where the quantity of oil extracted...

Let us define "peak oil" as a point in time where the quantity of oil extracted and consumed (let's just assume these are the same) reaches a maximum and then starts to decline. Based on economic theory, (in other words, I'm not asking you to predict anything specific about the oil market in the real world, just a general theory question) should we expect this period of declining production to be accompanied by high and rising prices or by low/falling prices? Give a brief explanation using graphs where appropriate.

Expert Solution

The question says that the oil extraction and consumption both starts to decline after reaching the peak point. This implies that both demand (consumption) and supply (extraction) starts decling.

The decline in both demand and supply can be analysed using three cases:

1. Decrease in demand = decrease in supply. In this case, the demand and supply curves will shift backwards in equal proportions. Due to this, the price level will stay the same.

2. Decrease in demand is higher than decrease in supply: In this case, the price level will decline. This is because the decrease in demand being higher will not put a pressure on the price level.

3. Decrease in supply is higher than decrease in demand: In this case, the net effect is that demand will be higher than the supply after the reduction. Due to this, there will be pressure on prices.

Rahul Sunny answered 1 year ago

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