Producers could try to cooperate and jointly withhold

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Unformatted text preview: t control the world supply and its members self-interests are to produce the quantities that give them the maximum attainable profit. So even though the global oil market has some big players, they don’t fix the price. Instead, the actions of thousands of buyers and sellers and the forces of demand and supply determine the price of oil. So how have demand and supply changed? Because the price has increased with an unchanged quantity, demand must have increased and supply must have decreased. Demand has increased for two reasons. First, world production, particularly in China and India, is expanding at a rapid rate. The increased production of electricity, gasoline, plastics, and other oil-using goods has increased the demand for oil. Second, the rapid expansion of production in China, India, and other developing economies is expected to continue. So the demand for oil is expected to keep increasing at a rapid rate. As the demand for oil keeps increasing, the price of oil will keep rising and be expected to keep rising. A higher expected future price increases demand yet further. It also decreases supply because producers know they can get a greater return from their oil by leaving it in the ground and selling it in a later year. So an expected rise in price brings both an increase in demand and a decrease in supply, which in turn brings an actual rise in price. Because an expected price rise brings an actual price rise, it is possible for expectations to create a process called a speculative bubble. In a speculative bubble, the price rises purely because it is expected to rise and events reinforce the expectation. No one knows whether the world oil market was in a bubble in 2008, but bubbles always burst, so we will eventually know. Figure 1 illustrates the events that we’ve just described and summarizes the forces at work on demand and supply in the world market for oil. Price (dollars per barrel) 68 6/22/09 200 Rise in incomes in China and India and rise in expected future price increase demand 175 S2008 150 Rise in expected...
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This note was uploaded on 04/04/2012 for the course ECON 251 taught by Professor Blanchard during the Spring '08 term at Purdue University-West Lafayette.

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