Exec SupplyDemand

7/27/2019 Exec SupplyDemand

1/27

Supply and Demand


2/27

Gas prices at record high

US$

West Texas Intermediate (Bbl)

Prices of Oiland Gasoline

continue to

climb!

What

happens if

Iranian oil is

taken

offline?
http://money.cnn.com/


3/27

August 25, 2005

Rising Price of Oil Pushes S.&P. to Negative

Territory

By ERIC DASHOil 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 loweryesterday; 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."
http://query.nytimes.com/search/query?ppds=bylL&v1=ERIC%20DASH&fdq=19960101&td=sysdate&sort=newest&ac=ERIC%20DASH&inline=nyt-perhttp://query.nytimes.com/search/query?ppds=bylL&v1=ERIC%20DASH&fdq=19960101&td=sysdate&sort=newest&ac=ERIC%20DASH&inline=nyt-per


4/27

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 barrierspreventing 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.


5/27

Law of Demand:There is always an inverserelationship between the price of a good and thequantity that consumers would like to purchase.Reason:

Consumers have limited income.

The price that consumers will pay for an extragood will be no greater than the extra benefitthat they receive from it.

People face diminishing returns from consumingany 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 thegood before.


6/27

Representation of a Hypothetical Oil

Demand Schedule

P

Q

US$/bbl Mil. BblP Q

30 31867.11

35 31568.86

40 31312.77

45 31088.650 30889.43

55 30710.37

60 30547.8

65 30399.01

70 30261.9

75 30134.8

80 30016.4

85 29905.6

90 29801.51

95 29703.39

100 29610.59


7/27

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 producingit (marginal cost).

Producers have decreasing returns to productionand therefore increasing costs. To induce them

to produce greater amounts, they must becompensated for these increasing costs withhigher prices.


8/27

Why do supply curves slope up?

Firms will only increase supply when pricesrise because their costs as production increases.

Producing extra goods generates increasing

costs because some inputs are fixed and theflexible factors of production will have

diminishing returns.

Example: A busy McDonalds can sell more burgersby adding more McWorkers, but effectiveness of

workers is limited by amount of Cash registers,

Ovens, and ultimately Space.


9/27

Representation of a Hypothetical Oil Supply

Schedule

US$/bbl Mil. BblP Q

30 29893.38

35 30078.28

40 30239.36

45 30382.16

50 30510.48

55 30627.02

60 30733.8

65 30832.36

70 30923.89

75 31009.3580 31089.51

85 31164.99

90 31236.32

95 31303.95

100 31368.24

P

Q


10/27

Equilibrium

Equilibrium in the competitive market occurs

when the price is set at a level (P*) such that theamount that consumers want to buy is equal tothe amount that sellers want to sell (Q*).

Excess SupplyIf P were above equilibrium, sellerswould want to sell more goods than buyers wouldwant to buy. Competition between sellers wouldforce prices down.

Excess DemandIf P were below equilibrium,customers would want to buy more goods thanpeople would want to sell. Competition betweenbuyers would force prices up.


11/27

Competitive Market Equilibrium(Geometry)

SDP

Q

P*

Q*


12/27

Excess Supply

SDP

Q

P*

Q*

P


13/27

Excess Demand

SDP

Q

P*

Q*

P


14/27

Market Equilibrium

(Spreadsheet Problem)

Supply Demand

30 29893.38 31867.11

35 30078.28 31568.86

40 30239.36 31312.77

4530382.16 31088.6

50 30510.48 30889.43

55 30627.02 30710.37

60 30733.8 30547.8

65 30832.36 30399.01

70 30923.89 30261.9

75 31009.35 30134.8

80 31089.51 30016.4

85 31164.99 29905.6

90 31236.32 29801.51

95 31303.95 29703.39

100 31368.24 29610.59

At what price and quantity (to

closest $5) will the oil market

clear?


15/27

Elasticity: The Concept

How strong is the effect of a change in priceon the change in quantity supplied or

quantity demand. If the price effect is strong, we say the

supply/demand schedule is elastic.

If the price effect is weak, we say it isinelastic.

Strict definition to come


16/27

Shifting Curves/Changing Equilibrium

Changes in equilibrium result from shifts ineither the demand or supply schedule. Wethink of shifts in the curves as changes insupply or demand that are caused by factors

other than changes in the price of the good. Shifts in the demand curve lead to movements

along the supply curve resulting in changes inprices and quantities that move in the same

direction. Shifts in the supply curve lead to movements

along the demand curve resulting in changes inprices and quantities that move in different

directions.


17/27

What shifts a demand curve?

1. Changes in consumer preferences

2. Changes in consumer income

3. Changes in the prices of other goods.


18/27

Hypothetical Demand Shift

Consider that there is an increase in consumer incomesufficiently large that oil demand would increase by 5% if

the price level stayed the same. This event will increase

the demand for oil at any given price level. Demand

schedule shifts out/up. Equilibrium price and quantity rise.

At the old price level, there is a situation of excess

demand. As consumers, scramble to get more oil,

producers are able to raise prices.

Higher prices induce i) some cutbacks in oil use; and ii)

some additional production until supply is equal to

demand.


19/27

A Shift in the Demand Curve: A parallel increase in

the demand schedule at every price point.

Equilibrium Effect: Movement along the supply curve

S

D

P

Q

P*

Q*

P**

Q**

D

Shift in the

demand curve


20/27

A shift in the demand schedule

(Spreadsheet)

Supply Demand Demand'

30 29893.38 31867.11 33460.47

35 30078.28 31568.86 33147.31

40 30239.36 31312.77 32878.41

4530382.16 31088.6 32643.03

50 30510.48 30889.43 32433.9

55 30627.02 30710.37 32245.88

60 30733.8 30547.8 32075.19

65 30832.36 30399.01 31918.96

70 30923.89 30261.9 31774.99

75 31009.35 30134.8 31641.54

80 31089.51 30016.4 31517.2285 31164.99 29905.6 31400.88

90 31236.32 29801.51 31291.59

95 31303.95 29703.39 31188.56

100 31368.24 29610.59 31091.12

A 5% shift in the demandschedule

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 ondemand. .

What is the new equilibrium

price?


21/27

Shifts in Supply Curves Supply curves represent the extra cost of

producing a good which increases in the

number of goods produced. But other factors

may affect cost besides scale.

Cost Shifters

1. Changes in resource prices

2. Changes in Technology

3. Nature and Political Disruptions

4. Changes in Taxes on Producers


22/27

A Shift in the Supply Curve is a Movement

along the Demand curve-

Price and Quantity Move in opposite DirectionsSDP

Q

P*

Q*

P**

Q**

S


23/27

Equilibrium Effects of an Decrease in

Supply When there is some disruption, oil companies

produce less at any given price. Supply scheduleshifts in/up.

Equilibrium price rises/Equilibrium quantity falls. At the current price level, there is a situation of

excess demand. As consumers, scramble to getmore oil, producers are able to raise prices.

Higher prices induce i) some cutbacks in oil use;and ii) some additional production from othersources; until supply is equal to demand.


24/27

Quantity of Oil Use Accelerating

%

Growth in World Oil Consumption

World OECD ROW

Source: BP Statistical Review 2005


25/27

Analysis

Use observed information on oil prices and

quantities to assess strength of supply and

demand shocks in context of world events.


26/27

Learning Outcomes

Solve for equilibrium price and quantities

using graphical supply and demand model

or spreadsheet supply and demandschedules.

Explain qualitatively the likely

consequences of exogenous shifts in supplyand demand the likely causes of shifts in

equilibrium prices and quantities.


27/27

Negative Supply Shock

Negative supply shock like embargo on

Iranian oil would raise prices and reduce

quantity of oil available. But how much?

Documents

Exec SupplyDemand