Microeconomics: week 4
September 22, 2011
Effects of Supply and Demand on the Price of Oil
Each time you pull up to the pump or open your utility bill, you may notice the price of fuel may have changed. There are many factors that can influence fuel prices. The marketplace forces of supply and demand determine the price of fuel. If demand grows or if a disruption in supply occurs, there will be upward pressure on prices. By the same token, if demand falls or there is an oversupply of product in the market, there will be downward pressure on prices. Those principles apply at the service station level as well. If a retailer prices its gasoline too high, and without regard to competition, the retailer's customers may take their business to another station with lower prices. If a retailer loses enough volume, the retailer may then reduce prices in order to retain its customers. Competition among retail outlets thus affects pricing. You may notice that sometimes there are price differences between two gasoline stations on a busy street corner and between those outlets and the only station on a long stretch of highway. More choices generally mean more competition for business. And although retail outlets may sell gasoline carrying the brand of a major oil company, most dealerships are owned and operated by independent business people who are free to set the prices for their products and services. Like agricultural products, such as wheat and corn, and precious metals, such as silver and gold, crude oil is traded on the world market. Recently, crude oil prices have risen dramatically, driven by rising global demand and political instability in several oil producing countries. Crude oil prices are important in determining gasoline prices because crude is the primary raw material used to produce gasoline and other petroleum products. In some cases, the price of crude oil may account for up to half the price of a gallon of gasoline. While crude oil is...
References: Gramlich, Edward M. (2004). "Oil Shocks and Monetary Policy," speech delivered at the Annual Economic Luncheon, Federal Reserve Bank of Kansas City, September 16
Weiner, Robert J. (2002). "Sheep in Wolves’ Clothing? Speculators and Price Volatility in Petroleum Futures," Quarterly Review of Economics and Finance, vol. 42, no. 2, pp. 391-400.
Bernanke, Ben S. "Oil and the Economy." Speech presented at Darton College, Albany, Ga. Oct. 21, 2004. See www.federalreserve.gov/boarddocs
U.S. Energy Information Administration. "Short-Term Energy Outlook." 2004c. See www.eia.doe.gov/emeu/steo/pub/outlook.html.
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