The economic disruptions caused by COVID-19 have caused a dramatic fall in oil prices. On April...

The economic disruptions caused by COVID-19 have caused a dramatic fall in oil prices. On April 20th, 2020, the price of oil even became negative. Using a supply and demand diagram, explain clearly why this is happening

Expert Solution

This is a demand shock. Covid 19 has resulted in closure of many transport, travel, manufacturing and shipping activities. All these activities use oil and because of their closure, a demand shock has risen.In this particular case, the demand shock, shown by the arrow and the new demand is Demand`, is so severe that all the storages also became full. This meant demand effectively became zero. At this point, ideally supply should also become zero because there is no market. But the issue is that oil wells cant be shut easily and quickly, and both shutting them down and restarting them is a very expensive and long process. So they couldnt be shut down and the output quantity must be kept at original Qe. This can be maintained only at negative prices. As can be seen in the graph, the new demand curve, Demand`, meets the quantity Qe at negative prices!

Rahul Sunny answered 2 years ago

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