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August 25, 2005 Rising Price of Oil Pushes S.&P. to Negative Territory By ERIC DASH Oil prices climbed to another record yesterday, driving stocks lower and leaving the Standard & Poor's 500-stock index down for the year. All three major market gauges closed lower yesterday; the S.&. P.'s loss meant that for the first time since July 7, all three were in negative territory for the year. "Once oil decided that it was going to move higher and stay higher, that just took the starch out of any buyers in the stock market," said Joseph Liro, the chief equity strategist at Stone & McCarthy, an economic research firm in Princeton. "Oil is just the biggest single depressant on the market except for the oil stocks."
To think about commodity prices, economists first think about the theory of competitive markets
Competitive Markets have many buyers and many sellers who compete without barriers preventing rivals from entering or leaving the market. Participants in competitive markets are price takers, agents who behave as if their own behavior has no effect on market prices.
relationship between the price of a good and the quantity that consumers would like to purchase.
Reason: Consumers have limited income. The price that consumers will pay for an extra good will be no greater than the extra benefit that they receive from it. People face diminishing returns from consuming any given good. Each extra good consumed generates less marginal benefit than the good before Consumers will be willing to pay less for each extra good than they were willing to pay for the good before.
Law of Supply: There is a positive relationship between the price of a good and the quantity producers bring to the market.
In a competitive market place, producers are willing to sell an extra good as long as the price is at least as large of the extra cost of producing it (marginal cost). Producers have decreasing returns to production and therefore increasing costs. To induce them to produce greater amounts, they must be compensated for these increasing costs with higher prices.
Equilibrium
Equilibrium in the competitive market occurs when the price is set at a level (P*) such that the amount that consumers want to buy is equal to the amount that sellers want to sell (Q*).
Excess Supply If P were above equilibrium, sellers would want to sell more goods than buyers would want to buy. Competition between sellers would force prices down. Excess Demand If P were below equilibrium, customers would want to buy more goods than people would want to sell. Competition between buyers would force prices up.
P* Q* Q
Excess Supply
P
P
P* Q* Q
Excess Demand
P
P* P Q* Q
At what price and quantity (to closest $5) will the oil market clear?
A Shift in the Demand Curve: A parallel increase in the demand schedule at every price point. Equilibrium Effect: Movement along the supply curve P S
Shift in the demand curve
P** P*
D D Q* Q** Q
31867.11 31568.86 31312.77 31088.6 30889.43 30710.37 30547.8 30399.01 30261.9 30134.8 30016.4 29905.6 29801.51 29703.39 29610.59
Demand' 33460.47 33147.31 32878.41 32643.03 32433.9 32245.88 32075.19 31918.96 31774.99 31641.54 31517.22 31400.88 31291.59 31188.56 31091.12
A 5% shift in the demand schedule If price stayed constant, demand for oil would increase 5%.
But to get producers to produce more, price must go up which will have a counter-veiling effect on demand. .
What is the new equilibrium price?
1. 2. 3. 4.
A Shift in the Supply Curve is a Movement along the Demand curvePrice and Quantity Move in opposite Directions P D S S
P** P* Q** Q* Q
World
OECD
ROW
Analysis
Use observed information on oil prices and quantities to assess strength of supply and demand shocks in context of world events.
Learning Outcomes
Solve for equilibrium price and quantities using graphical supply and demand model or spreadsheet supply and demand schedules. Explain qualitatively the likely consequences of exogenous shifts in supply and demand the likely causes of shifts in equilibrium prices and quantities.