Business Economics The Price of Crude Oil

Question: Describe about the Business Economics for The Price of Crude Oil. Answer: Part 1 In the year 2015, the price of crude oil has decreased from $50.00 to $45.90. In this situation demand of crude oil has increased. This relationship between demand and price can be analyzed by law of demand theory of economics. Law of demand states that quantity bought of goods and service is a function of price. If the price of the product increases, demand of the product falls. However, if the price of the product decreases, demand of the quantity increases (Marshall, 2013). Below curve shows the response of quantity demanded due to the change in price. Demand curve is downward slopping; it indicates negative relationship between the price and demand. In the above curve, quantity is on the x-axis and the price is on y-axis. When price is (P1) then demanded quantity is (Q1). However, when price is decreased from P1 to P3, quantity demanded increase from Q1 to Q3. The above curve analyzes the negative relation in demand and price. 2. Over the period of last 6 month in 2015, price of crude oil has decreased by 30% and demand of crude oil has increased by only 2%. In the given situation, crude oil has an inelastic demand. Inelastic demand means if price of good changes by 1% then demand of good changes by less than 1% (Mucka, 2016). If the price goes up, buying habit of consumer stay same. At the same time, price of the good and service goes down, consumption remain unchanged. 3. Yes, the opinion expressed in source 1 related to the price elasticity of demand is acceptable. Demand elasticity of a commodity is influenced by the nature of its product. Crude oil is necessity good for a person like the manufacturer and producer of the oil. Hence, demand of oil is not much affected with fluctuations in price. Lower price of oil does not encourage more consumption and vice versa. At the same time, producer of the crude oil are willing to pay higher price to buy the raw material that is used to produces the crude oil, which they need (McEachern, 2016). As it can be analysis that crude oil is a necessity good and there are less substitutes available for the product related to crude oil, the demand for it is inelastic. 4. On the basis of the previous question analysis, producer should increase the price of oil because the demand of the product is inelastic. Price inelasticity of demand is beneficial for business in terms of profit. Additionally, in case of inelastic demand percentage change in demand is less than percentage change in price (Torras et al., 2015). It can be understood with the help of inelastic demand curve, which is as under- Figure 1: Inelastic Demand Curve From the above curve it is analyzed that when price of the product is P1, demand of the product Q1. At the same time, price is increased from P1 to P2; quantity demanded of the product is decreased from Q1 to Q2 that is a very less change in the quantity. In this situation, loss of the customers will be recovered by charging higher price from the existing customers. 5. As per the source 2, shale oil revolution has raised the production trend by 73% in the year 2008 to 2014 in US. Earlier, the crude oil production depended on the natural resources thereby restricting the supply but in the present context a high price elasticity of supply is required by the firms. So firms may take some actions to increase their supply (Braeutigam and Besanko, 2010). As per the source 2, to increase the supply of oil they adopted latest technology by which production and supply is increased. It can be understand by figure given below- Figure 2: Elastic supply Curve In the figure, quantity is on x-axis and price is on y-axis. The above curve analyzes that, when production and quantity supplied increases, price of the product is increased by the firms to generate higher profit. Part 2 The super market industry is the oligopolistic market. In this market, there are only few firms that make up the overall industry. These firms have a control on the overall price and they also have higher entry barriers. Under the oligopoly market, firms follow the policy of price rigidity; it is situation where price trends stay fixed in respect to change in the supply and demand. Moreover, firms produce homogeneous products and there are few firms, which prevents the entry of new firm in the industry. It can be analyzed from the source 1 that, these firms follow different pricing strategy to attract customers like discount strategy and premium pricing. From source 2 it can be analyzed that overall retail market of Australia is covered by 3 firms and the market share of other firms is only 2% in the Australian retail market. 2. No, it is not in interest to have the price discount war. Even though discounts attract more and more customer, in case of oligopoly market, if firm decrease the price, their market share does not increase. This is because as per the kinked demand curve it is assumed that the other firms dont want to lose their market share and they decrease in pricing so the market share of the other firms will be same (Tucker, 2013). Kinked demand curve can be made as below- Figure 3: Kinked Demand Curve The above curve explains that change in the variable cost may not lead to the increase and decrease in the profit maximizing price and quantity. The business might be stable at profit maximizing equilibrium point at quantity Q1 and price P1. Woolworth and Coles should take the premium pricing strategy. It directly affects the profit and the pricing strategy that helps to meet the sales objective of the firms. According to this strategy, firms should effectively use some unique products to increase their market (Einolf and Forgang, 2015). It can be explain in context of Woolworths and Coles with the implementation of game theory that is describe as below- There are different possibilities, which represent the market share of Woolworth and Coles: If they both adopt premium pricing, they both would able to get 1% market share. If one adopted premium, the premium firm would able get 2% market share and other one would get 0% market share. If neither adopted premium pricing, they would get 0% market share. Figure 4: Game theory The best possibility for both would be adoption of the premium pricing strategy which will allow them to gain equal market share in the supermarket industry (McMillan, 2013). 3. Perfect competition is market structure for vegetables market provided by the farmers. This can be identified from source 2 which shows that there are many firms who produce homogeneous and identical products. As it can be seen in the source 1, that famers are the price taker. They have to sell their product on whatever price offered by the firms. That means price war of supermarket make it difficult for farmers to stay in the business. 4. Individual vegetables producer falling their prices due to the price war because in the perfect competition there are many farms and all the firms produce homogeneous product. If one vegetables producer try to increase the price, it would find that firms collecting vegetables from different farms. Additionally, a single farmer of vegetable is unable to affect the price of entire market (Sinclair and Caimcross, 2014). It can be demonstrated by the perfect completion demand curve, which is as below- Figure 5: Perfect Competition Demand Curve In the above curve black line indicates the marginal cost, blue line indicates the average cost and red line indicates the demand of the vegetables. The above curve analysis that in the perfect market competition demands for the vegetables is likely to be down sloping, which inversely related with the price. In the long run small farmers will be forced to leave the market, because in the perfect market competition firms are freely able to enter and exit the market in response to potential profit. The firms cannot make economic profit as well as economic loss in the long run; they can only make normal profit and break even. 5. If individual farmers improve their technology then they will be able to overcome the situation of price fall. With the implementation of new technology, famers are able to reduce their average cost in long run. It will help them in the economic gain and constant returns. After reducing the average cost, farmers will easily sustain in market for the long-run even when the price falls. Reference Braeutigam, R., and Besanko, D. (2010) Microeconomics. US: John Wiley Sons. Einolf, W.K., and Forgang, G.W. (2015) Management Economics: An Accelerated Approach: An Accelerated Approach. UK: Routledge. Marshall, A. (2013) Principles of Economics. US: Springer. McEachern, A.W. (2016) Microeconomics: A Contemporary Introduction. US: Cengage Learning. McMillan, J. (2013) Game Theory in International Economics. UK: Taylor Francis. Mucka, S. (2016) Price Elasticity of Demand and its effect on Revenue. Germany: GRIN Verlag. Sinclair, P., and Caimcross, A. (2014) Introduction to Economics. UK: Butterworth-Heinemann. Torras, M., Roach, B., Nelson, A.J., Harris, M.J., and Goodwin, N. (2015) Principles of Economics in Context. UK: Routledge. Tucker, B.I. (2013) Microeconomics for Today. Australia: Cengage Learning.