Harris_Issue_Update_1__Oil_Prices

Harris_Issue_Update_1__Oil_Prices - Introduction In the...

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Introduction In the past few years gasoline prices in the United States have increased substantially from around $1.10 per gallon in late 2001 (see Figure 1). Average gas prices first climbed above $2 per gallon in mid-2004, and then rose further past $3 per gallon in the wake of Hurricane Katrina in Sept. 2005. Figure 1: U.S. Average Retail Gas Prices, Jan. 2000 – Sept. 2005. Source: U.S. Energy Information Administration, http://www.eia.doe.gov/oil_gas/petroleum/data_publications/wrgp/mogas_history.html Why have gas prices risen, and is the change temporary or permanent? This question raises issues both about the workings of markets and, more broadly, about environmental and resource economics issues. (See text Chapters 3, 12, and 13). Viewing the issue from a perspective of economic analysis, we can broadly classify these explanations into demand-side and supply-side factors. Let’s first consider a couple of demand-side explanations, then some supply-side issues. 1
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Explanation #1: Domestic Demand Increase Supply-and-demand theory implies that if the demand for a good increases, we would expect its market price to rise and the quantity sold to increase (see Chapter 3). Is this at least part of the explanation for the recent increase in gas prices? While the data are not available to plot a complete demand curve for gasoline, we do have significant data on the market price and quantity sold. Figure 2 presents both the annual average market price and quantity sold for 1990-2004. Note that the price of gas has been adjusted to account for inflation. Figure 2: Average U.S. Gas Prices and Quantity Sold, 1990-2005 Source: U.S. Energy Information Administration, http://www.eia.doe.gov/oil_gas/petroleum/info_glance/gasoline.html Figure 2 shows that the quantity of gasoline sold in the U.S. has generally been steadily increasing for the last fifteen years. During this same period gas prices have fluctuated – declining in real terms during most of the 1990s and then increasing in the last few years. 1 Based on the data in Figure 2, do you believe that an increase in domestic demand has been a primary factor leading to the increase in the price of gasoline in the last few years? Can this factor alone explain the data in Figure 2? 1 Figure 2 only shows the annual averages. Thus variations in prices and quantities within a year are not represented. In general, the quantity sold consistently rises during the summer months regardless of price. 2
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Explanation #2: International Demand Increase A second possible explanation is that the price of gasoline in the United States has increased because international demand has increased. The United States imports a significant portion of its oil – currently about 58% of total petroleum consumption (see text Figure 13-5). Thus for over half of its oil, the U.S. must compete with other countries on the world market and pay the going world market price. Even if U.S. demand were constant, an increase in demand in other
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This note was uploaded on 12/20/2010 for the course AEM 25 at Cornell University (Engineering School).

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Harris_Issue_Update_1__Oil_Prices - Introduction In the...

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