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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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