Deamnd and supply and the oil price

As every Economics students know market prices are determined by demand and supply. The price of oil is no different.

Since July 2014 crude oil prices have fallen from $116 a barrel to a low of $28.

Many have suggested that the oil price is about to climb again, but the International Energy Agency (IEA) has said that demand and supply factors don't support that. (Shout out to my old friend Trevor Morgan, the principal author of the IEA report.)

The article below provides some detail, but in brief the IEA don't see demand climbing and believe supply in 2016 will actually be higher than in 2015. With oil stocks rising at 2 million barrels a day at present this already suggests that the market equilibrium price is still higher than the market clearing price.

The ABC covers the story here

Questions.

1. Draw a demand and supply diagram to show the current state of the oil market as described by the IEA.

2. Draw a supply diagram for the oil market showing the change that the IEA predicts will occur over 2016. (Use a 2015 and 2016 label on two demand curves and two supply curves). Describe and explain the new equilibrium in the oil market by the end of 2016.

This is an article that describes a fundamental concept for all Economics students. IB students might consider it for a microeconomics IA.

The falling oil price

The plummeting oil price is one of the major economic events that will affect the world economy in 2016. For students of economics it is impossible to ignore. (Note for Australian students the parallel with commodity prices should be obvious.)

The chart, from Tradingeconomics.com, shows the oil price for the last five years. The fall from $110 to $30 a barrel will impact the economies of every nation because oil is fundamental to the worlds energy supply. However the impact on each country is going to be different.

This is a huge subject and so today I will concentrate on Russia as an example, a major oil exporter.

It is fair to say that in the last twenty years oil and gas exports have allowed the Russian economy to expand and the standard of living of Russians has been improved due to this. In terms of macroeconomics Russia's net exports (X - M) has boosted Aggregate Demand (AD) and taxes on oil and gas (collected in a variety of ways) have funded a large proportion of Russia's government spending (G).

The fall in the oil price is disastrous for Russia. As net exports fall so does AD. The government finds that its revenue is falling and they must cut government expenditure to cope with their budget deficit, and so reduce AD further.

But the story is the exact opposite if you are an oil importer. Next exports will rise, as the cost of imports fall, shifting AD to the right. Also energy costs are an important part of firms costs and so AS moves to the right too.

So the result for Russia and other exporters, such as Venezuela, is a budget crisis,  lower output, higher unemployment and possible deflation. Oil importers may see higher growth and employment.

There are other effects and considerations, not the least of which is the implication for exchange rates (see article).  For now we will leave it at the initial effects on the AD/AS model and a classic example of an 'asymmetric shock' - the same event affecting countries in opposite ways.

The BBC cover the effect on Russia here

Questions:
1. What are the implications for the macroeconomic goals of Russia of the oil price fall.
2. How should Russia's economic policy mix change as a result?
3. What are the implications for the macroeconomic goals of non-oil producers of the oil price fall.
4. How should non-oil producers economic policy mix change as a result?
5. How can exchange rates help 'soften the blow' of the oil price shock?

This story is very applicable to IB with many avenues for an IA on trade and exchange rates as well as macroeconomics. If falling oil prices are chosen for an IA then students would be well advised to focus on just one aspect.
For VCE there are clearly lessons that can be applied to falling commodity prices.