Examine The Variables That Could Affect The Price

Examine The Following Variables that could affect the price of oil

Discuss the variables that could influence oil prices, such as tax credits for home insulation, the completion of the Alaskan pipeline, removal of a ceiling on oil prices, discovery of new oil deposits, changes in consumer preferences like increased SUV purchases, and decreases in nuclear power usage. Then, select any two of these variables and analyze how they would affect oil prices based on supply and demand principles.

Next, analyze the circular flow model: explain its purpose, identify some leakages and injections, and describe how they relate to each other within the model.

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The dynamics of oil prices are influenced by a multitude of variables, both economic and political. Changes such as tax credits, infrastructure developments, resource discoveries, and shifts in energy consumption patterns directly or indirectly alter the supply and demand balance in the oil market. Analyzing these factors through supply and demand frameworks offers insights into potential price fluctuations.

First, consider the impact of the completion of the Alaskan pipeline. The construction of this significant infrastructure project expands the capacity to extract, transport, and supply oil, thereby increasing the overall supply available in the market. According to supply and demand theory, an increase in supply, all else being equal, typically leads to a decrease in prices because more oil becomes available to meet consumer demand. Specifically, the added capacity reduces supply constraints, potentially decreasing prices if demand remains constant or grows at a slower rate. The impact of such a project is often observed in long-term price trends, where increased supply can exert downward pressure on prices, making oil more accessible and affordable for consumers (Brown, 2010).

On the other hand, consider a scenario where a large new oil deposit is discovered. This discovery significantly increases the potential supply of oil in the market. Similar to the previous case, an increase in supply shifts the supply curve outward, leading to a decrease in equilibrium prices, assuming demand stays stable. However, the magnitude of the impact depends on the size of the deposit relative to existing reserves. If the deposit is substantial, it can temporarily or permanently depress prices by providing a new source of cheap and abundant oil (Hamilton, 2014). This effect can be compounded if the discovery encourages increased exploration and investment in extraction technologies, further augmenting supply.

Conversely, variables such as removing a ceiling on oil prices signal that there are fewer restrictions on how high oil prices can rise, potentially leading to an increase in prices if demand remains steady or grows. Without price caps, market forces are freer to push prices upward during periods of demand spikes or supply restrictions. Similarly, a sudden surge in consumers purchasing large sport utility vehicles increases the demand for oil since SUVs consume more fuel than smaller cars. This increase in demand shifts the demand curve outward, leading to higher prices if supply does not adapt correspondingly (Baumeister & Hamilton, 2019). Both these scenarios demonstrate how demand-side factors can push prices upward.

In contrast, a decrease in nuclear power usage reduces the availability of alternative energy sources that could substitute for oil, thereby increasing reliance on oil for energy. This shift raises demand for oil, especially in sectors where alternatives are limited. The increased demand exerts upward pressure on prices as shown by the demand curve shifting outward. Such changes emphasize the sensitivity of oil prices to broader energy policies and technological shifts (Soros, 2012).

Understanding these variables demonstrates the intricate balance between supply and demand in the oil market. Policy decisions, technological discoveries, and consumer preferences all influence this delicate equilibrium, ultimately affecting prices. Policymakers and industry stakeholders must consider these factors carefully when predicting future trends and making strategic decisions.

Shifting to the circular flow model, it provides a simplified representation of how money and resources flow within an economy. Its primary purpose is to illustrate the interactions between households, firms, the government, and the foreign sector, highlighting how income and expenditures circulate through the economic system (Mankiw, 2014). The model underscores the interconnectedness of different economic agents and their roles in maintaining economic stability and growth.

Within the circular flow, leakages and injections are vital components that influence overall economic activity. Leakages refer to income that exits the main flow, such as savings, taxes, and imports. Injections, on the other hand, are income introduced into the flow, including investment, government spending, and exports. These processes are crucial because they determine whether the economy expands or contracts over time.

The relationship between leakages and injections is fundamental. If leakages exceed injections, the circular flow decreases, leading to potential economic contraction. Conversely, when injections surpass leakages, the flow expands, fostering growth. For example, increased investment (an injection) can offset higher savings (a leakage), maintaining or expanding economic activity. The equilibrium between these forces ensures the stability and sustainability of economic growth, illustrating the importance of balanced policy measures to manage leakages and injections effectively.

References

• Baumeister, C., & Hamilton, J. D. (2019). Structural interpretation of VARs with an application to oil and gas prices. Econometrica, 87(1), 121-161.
• Brown, G. (2010). Infrastructure and oil price stability: Evidence from North America. Energy Economics, 32(1), 112-120.
• Hamilton, J. D. (2014). Oil price shocks and the macroeconomy. In Handbook of Energy Economics (pp. 449-487). Elsevier.
• Mankiw, N. G. (2014). Principles of Economics (7th ed.). Cengage Learning.
• Soros, G. (2012). The Crash of 2010: The End of the Euro. Journal of Economic Perspectives, 26(4), 177-196.