Part 1:1
The crude oil price in 2015 can be said to have fallen and hit the lowest record ever irrespective of a small rise experienced from April to June (DeHaemer, 2015). This was deducted from the first graph on source 1- oil opinion piece. From the same source but on the second graph, DeHaemer confirmed that the cheap price resulted in an increment in demand when he quoted “The good news, of course, is that due to the lower prices demand is up”. Overall the increase in demand was by 2 %. The economic theory explaining this movement is that oil is a normal good where price decrease causes demand increment.
Initially consumers demanded quantity level Q* at the price level P*. The price decreased to P1 causing a demand increased to Q1. Since even at a very low price the demand did not change as much, there is an economic theory of inelasticity of demand exhibited in the diagram.
Part 1:2
Morgan (2014) gave the following formula for Price elasticity of demand
Formula PED =
PED =
% change in Oil demand is +2%
% change in oil price is -30%
PED = = = -0.07
= -0.07
The negative sign results from the negative relationship. The oil PED is -0.07 with a negative sign indicating an inverse relationship. Since the PED of 0.07 is too low, the demand is said to be price inelastic.
Part 1:3
I fail to agree with the opinion since on oil defining price elasticity of demand. The opinion expresses the fact that demand changes significantly when the price of the commodity falls. This is not the case for crude oil; even at very cheap prices, the quantity demanded does not increase so much like for other normal goods. I would only agree with the opinion price if it noted that commodities like crude oil are the ultimate definer of price inelastic of demand where roughly the same quantity is demanded even at lower price level. Price changes doesn’t have much influence on the demand unless the change is too big. Some of the uses of crude oil requires fixed amounts of which cannot be adjusted even if price changes.
Part 1:4
The advice I would give to a crude oil producers is to raise price as much as possible. Since from the sources above we have come to a conclusion that price level have no much influence on the crude oil demand, even at a higher price, the consumers will still demand almost the same quantity level which would lead to revenue increment. This is also the fact that lowering prices doesn’t increase revenue as the consumers don’t respond much and increase their demand. The decision of increasing the crude oil price is reached by holding all other factors constant such as the market structures and competition level.
Table: Assumed Price and Quantity demanded for crude oil
|
Price |
Quantity Demanded |
|
40 |
20 |
|
50 |
18 |
The price of crude oil initially was $ 40 with consumers demanding 20 units. The total revenue for the supplier is obtained by PQ = 40*20 = $ 800. If the producer increases the price from $ 40 to $50 a barrel, consumers demanded 18 units which is 2 units lower from the initial demand. The total revenue for the supplier changes to PQ = 50*18 = $ 900. In comparison between the two revenues made by the producer, it is noted that the producer makes more profit by increasing prices. Thus this is the best pricing strategy for the producer.
The new technology has increased the production of shale oil and this has resulted in a falling price elasticity of supply. The oversupply of oil by the U.S. has resulted in the crude oil price to fall to low levels. Even at lower prices, competition for market share is continuing causing the supply to continue rising. Thus, since price is not influencing the supply level, the shale oil can be concluded to have contributed to a fall in PES for crude oil. The nature of the market structure for crude oil helps in the explanation of inelasticity of supply for crude oil; it experiences oligopolistic competition. Under this competition, the players are in active competence of markets share and thus they always employ the price cut strategy. Some players in the crude oil market have large storages such that they can sell for lower prices for long without much risk of closure. This may end up driving some of the competitors out of the market. Economists have also noted that there exist rigidness in the response of crude oil supply to price changes (Konrad, 2012).
The Australian supermarket industry has an oligopoly market structure. The first source is telling us that there are supermarket giants. One characteristic of oligopoly is that there are several big firms that dominate the whole market (Birou, 2012). It is also telling us that the giants are competing for markets share. For instance Coles is offering price discounts to attain more market share. Another characteristic of oligopolistic competition is using price cut strategy to attain large market share (Abourizk, 2017). The second source shows that the markets share for the Australian food retail sector is owned by very few firms with 3 firms owning 95% of the whole market (Coles 37%, Woolworths 43% and AIG 15%). The complaint on price wars between the supermarkets by the farmers is also an indicator of own price making while is another characteristic.
The price war between Coles and Woolworth is of own interest. Each firm is offering price discounts in an attempt to steal the customers of the other firm. The search for a market share is the major reason for the price war discounts.
Oligopoly markets maximize profit by producing at the level where MC = MR. Mostly oligopoly firms produced and sell at quantity level Q* and price P*; this is at point e. the demand curve for oligopolistic competition is negatively sloped just like any other demand curve, except that it has a kink at point e. the kink is explained by price change rigidities where players don’t use price increment strategies but only employ price cut ones. The demand curve is dD’. At any price above P*, the demand is more price elastic while at any price below P*, the demand is price inelastic. Thus for a player to raise price, its demand follows the segment ed and its demand falls. For player to lower price, it follows the eD’ segment since it is not able to raise its demand as all other players follow. At the kink there is a marginal curve gap where any MC change does not affect the produced quantity.
The Australian vegetable farmers exhibit a perfect competition market structure. In source one it is deducted that the farmers are complaining of the prices they are being offered by the supermarkets. One characteristic of this market structure is that the players are price takers. Source two shows that there are 17,784 direct firms’ sales to the supermarkets. Another characteristic of this market is that the players are too many but small. With many number of direct sales to the supermarket, each of the selling farm is looking forward to sell its produce in this insufficient market. Thus, the supermarkets take advantage of the big market competition and offer too low prices.
Individual farmers are suffering from the low prices offered to them by the supermarkets because it has resulted in a reduction in revenue. Given the production costs, some farmers will either make too little revenue whereas others will make losses. Some individual farmers will exit this market in the short run for more profitable ventures.
The profit for a competitive market is maximized by producing at MC=MR. in the short run, firms could be very many such that they make economic losses or could be too small such that they make abnormal profits. In this case, the firms are very many and thus making economic losses. The ATC is greater than the MR. In the short run, economic losses allows for exit from this market. Free entry and exit is an important characteristic for this market. The weak suppliers will close down until there are no more losses made. At the point where the firms break even, no more exit will be experienced. This will be in the long run as exhibited in the diagram below.
In the long run, the minimum ATC=MR and thus the firms only break even. So no exit in the long run.
As it has been concluded in the diagram in part 2:4, the ATC is high in the short run with the presence of many firms and this explains the reason for exiting the market. Technology has always been argued to contribute to increased efficiency of production. Therefore, such an innovation would help a farm to produce at a lower cost (Betz, 2011). Irrespective of the lower price of outputs, the farms with improved innovation will be able to operate to the long run since reduced costs will increase revenues or rather will offset the losses incurred otherwise. New technology if it will not help in reduction in costs, it will increase the production level. The sale of large quantity of output will raise more revenue. According to D’Haese (2003), small farmers new technological innovation to transform and further agricultural production. In addition to the decrease in production costs, technological innovation raises the quality of output and the variability of output is reduced.
References
Abourizk, R. (2017). Oligopoly: Definition, Characteristics & Examples. [Online] Study.com. Available at: https://study.com/academy/lesson/oligopoly-definition-characteristics-examples.html [Accessed 26 May 2017].
Betz, F. (2011). Managing technological innovation: Competitive advantage from change. Hoboken, N.J: Wiley.
Birou (2012). Oligopoly: Characteristic and Conditions for an Oligopolistic Market! [Online] Docsity.com. Available at: https://www.docsity.com/en/news/economics/oligopoly-characteristic-conditions-oligopolistic-market/ [Accessed 26 May 2017].
DeHaemer, C. (2015). Best Potential Returns from Oil. [Online] Energyandcapital.com. Available at: https://www.energyandcapital.com/articles/best-potential-returns-from-oil/5131 [Accessed 26 May 2017].
D’Haese, M. (2003). Local institutional innovation and pro-poor agricultural growth: The case of small-woolgrowers’ associations in South Africa. Antwerpen u.a.: Garant.
Konrad, T. (2012). The End of Elastic Oil. [Online] Forbes.com. Available at: https://www.forbes.com/sites/tomkonrad/2012/01/26/the-end-of-elastic-oil/#20e13a1d36d6 [Accessed 26 May 2017].
Morgan, K. (2014). Price elasticity of demand for Mylan laboratories, Pittsburg. [Place of publication not identified], Grin Verlag Gmbh.
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