Question

1. Last week oil prices, which are determined by the market and not individual producers, became negative. Graphically show what happened to the demand curve, marginal revenue curve, and profits/losses of an individual oil producing firm. Please label everything.

Answer 1

A fall in oil prices should cause a reduction in transport and fuel costs for firms. Consumers who will also benefit from the lower prices of transport and fuel. The lower oil prices will effectively increase their disposable income and enable them to spend more on other goods

Because oil is the most traded commodity and has a significant bearing on global transport costs, it should lead to inflation and can lead to higher rates of economic growth.

However, sometimes oil prices crash because there are fears of an economic recession. In this case, falling oil prices are not sufficient to increase economic growth because other factors keep growth low. Also, if oil prices fall sufficiently, it can cause some oil firms to go out of business and this causes a rise in bad debts. The crash in oil prices in 2020 is indicative of the economic recession and prices have fallen so far that many oil firms will be forced out of business, causing job losses and falling investment.

Also, falling oil prices will have differing effects depending on the country. Oil importing countries (e.g. Germany, Japan, India) will generally benefit from oil lower prices, but developing economies who rely on oil exports (e.g. Russia, Venezuela) could see a significant fall in export revenue.