Isues in economics today 6th by guell chapter38

Chapter 38
Energy
Prices

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Chapter Outline
• Historical View
• OPEC
• Why Prices Change So Fast?
• What Will The Future Hold?
• Kick It Up A Notch

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Real Oil and Gas Prices
2005 dollars Per gallon (1 barrel=42 gallons)

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Historical Events
Relating to Oil and Gas Prices
• 1972 Arab-Israeli War
• US support for Israel prompted an embargo by Arab oil
producers against the US and Europe. This led to a
significant increase in crude oil prices.

• 1979 Iranian Revolution
• Iran’s Islamic revolution led to instability in the Persian
Gulf. This led to a significant increase in crude oil prices.

• 1980’s
• Rapid increases in profits led to significant discoveries
of oil in Mexico and the North Sea

• 1980-1988 Iran-Iraq War
• The war led to increased production by both parties as
each needed to fund their war effort. This caused a
precipitous fall in crude oil prices.

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World Oil Reserves
Group

Billions of Barrels in
Reserve

Percentage of
World
Reserves

Persian Gulf

747

60%

Non-Persian
Gulf OPEC

181

15%

Rest of the
World

310

25%

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OPEC
• The Organization of Petroleum
Exporting Countries (OPEC)
• Algeria, Indonesia, Iran, Iraq, Kuwait, Libya,
Nigeria, Qatar, Saudi Arabia, United Arab
Emirates, and Venezuela

• OPEC began as a cartel.

• A cartel is an organization of
individual competitors that join
to form as a single monopolist.

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Was OPEC a Cartel?

OPEC production has always been a significant part of the oil
market but it has never reached the level of monopoly. The cartel
model is still useful because it has been a dominant player.
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The Cartel Model
Market for Oil

P

P

S=MC

One Country’s Oil
MC
Profit
Profit
ATC
MR’

Pcartel
PPC

MR

D
Qcartel

MR

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QPC

Q

Qquota

QPC Qcheat Q

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Why Oil and Gas Prices Change
So Fast
• Because expected price is a determinant of
supply and demand a world event that

causes people to expect a price increase
will
• Increase current demand (as middlemen and
consumers try to buy as much as possible)
• Decrease current supply (as middlemen and gas
stations try to hold onto their current stocks)

• This causes an immediate increase in
prices.

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Historical Events
Relating to Oil and Gas Prices
• 1990
• 1992-1998
• 1999
• 2003
• 2004-2005
• 2007
• 2008
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Iraq Invasion of Kuwait

OPEC massive
overproduction
OPEC discipline
US invasion of Iraq
Hurricanes in the Gulf of
Mexico
Iran-US tensions; Commodity
Speculation
Global Financial Crisis
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From $1 to $4 in Ten Years

1)
2)
3)
4)
5)
6)
7)

OPEC production cuts; Low stocks of oil; bad weather
Release of oil from the Strategic Petroleum Reserve; recession
Political unrest in oil producing Venezuela and Nigeria; War in Iraq
Hurricanes Damage Platforms in the Gulf of Mexico
Threatened Conflict b/w U.S. Iran

Global Commodity Speculation
Global Financial Crisis
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Gasoline Prices 1998-2008

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Gasoline Prices and Hurricanes

A significant portion of refining capacity in the US is in the Gulf of Mexico
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Electricity
• Residential electric power tends to
be sold by a regulated monopoly.
• It has been a monopoly because of
significant barriers to entry.
• It has been regulated because prices
would be much higher than is
socially optimal.

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Types of Monopolies
• Simple Monopoly: a monopoly in
which marginal costs of production
are rising.
• Natural Monopoly: a monopoly in
which marginal costs of production
are falling.

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Monopoly in the Market for
Residential Electricity
• The market for residential electricity is
likely to be a natural monopoly for
nuclear power because of the very
high fixed costs (transmission lines
and the power plant and diminishing
marginal costs.)
• The market may be characterized as a
simple monopoly or natural monopoly
for coal or gas generated electricity.

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An Unregulated Simple Monopoly
MCMonopoly

P
Pmonopoly

MR
Qmonopoly

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D
Q

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An Unregulated Natural Monopoly
P

Pmonopoly
D

MR
Qmonopoly
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ATC
MCMonopoly
Q

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An Regulated Simple Monopoly
MCMonopoly

P
Pmonopoly
Pregulated

D

MR
Qmonopoly Qregulated
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Q

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An Regulated Natural Monopoly
P

Pmonopoly
D

Pregulated

MR
Qmonopoly

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Qregulated

ATC
MCMonopoly
Q

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