WARWICK UNIVERSITY HIGHER EDUCATION FOUNDATION PROGRAMME

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Explain the major factors causing the large oil price changes

Economics Coursework 1
Qiujing,WANG
7/11/2011

GROUP B

Crude oil, as a scarce resource, plays an important role in modern society. It is refined and separated into a large number of consumer products. For example, crude oil is used primarily in the form of petrol and diesel to power vehicles, and which is the main fuel for transport. In addition, plastic is also made from oil, which is used widely in our daily life, from car parts to soft drink bottles. Plastic makes our life easier and better. Moreover, clothing is not unable to product without oil, as nylon and polyester are made from oil as well. Although oil is widespread used in our life, it is regarded as non-renewable fossil fuel. Because it takes millions of years for the earth to transform dead organic materials into crude oil, which means when the last barrel of oil has been pumped from the ground, there is no more. In recent years, there is rapid increase in oil price due to a combination of demand and supply factors (as shown in the diagram 1). Therefore the purpose of this essay is to explain the main factors causing the crude oil large price changes.

OPEC Basket Price:

Diagram 1

Demand and supply are really important concepts in economy, for it is a useful tool to explain the price and output changes of goods and service. Therefore, crude oil is no exception. Firstly, analyzing the demand factors of crude oil price changes. The demand for a product is the quantity that willing and able to buy at each and every price (Gillespie, 2011,P36). In addition the general law of demand is “the higher the price the smaller the quantity demanded.” We can define the law by using demand curve as shown below. (Diagram 2):

Price

P1

P0 Demand

Q1 Q0 Quantity Diagram 2

The demand curve clearly illustrates that the price tend to be influenced by the quantity demand. Therefore the increasing oil price is relation to the booming demand of oil. There are three main factors tend to affect the raising demand of oil, firstly, the rapid economic growth in China and India has raisin the real incomes, thus the consumers are able to purchase more crude oil products. Moreover, the countries need to import lager number of oil to fuel their economy.
Then, the real price of cars has fallen which tends to increase the demand of crude oil products, in others words, the consumers will purchase more crude oil price in response to the decrease price of cars. Finally, the world oil reserves are becoming depleted, so the Hubbert Peak Theory (Wikipedia) has also encouraged the speculators to buy more oil. Based on these factors, the oil demand curve will shift to the right from D0 to D1, which means that at the original quantity Q0, the price now increase from PO to P1. (See diagram 3)

Price P1

P0

D1 D0

Q0 Quantity Diagram 3

Then, Exploring the supply factors. The supply of a product is the amount that producers are willing and able to produce at each and every price, all other things being unchanged (Gillespie, 2011, P79). In addition, the basic law of supply is “the higher price the larger quantity supply.” As shown below (Diagram 4):