Saudi Arabia Oil Crisis: Analysis Of Microeconomic Concepts

Introduction

Article Summary

The Financial time (McCormick et al. 2019), released a news article on the September 16th this year titled “Oil rallies 10%; Saudi production may take months to recover- as it happened.” This article, describes the Saudi Arabia Oil crises that has caused an increase to the prices of oil by 20%, which a similar incident hasn’t occurred for over a decade since Saddam Hussein’s invasion of Kuwait in 1990 (McCormick et al. 2019). Saturday the 14th of September, Saudi Arabia’s oil plant erupted in an explosion. This plant had experienced serval attacks in the past by Al Qaeda however these attacks were prevented before they reached the complex’s gate (Krauss 2019) . United States has announced that the explosion was carried out by Iran due to political tensions between these three countries, Iran- backed Houthi militias in Yemen have claimed responsibility for the incident have confirmed the statement . The Saudi Arabi oil processes plant produced 9.8 million barrels a day which has now been cut down by an estimated half as a result of the incident. Saudi Arabia is looking at weeks without full production capacity as it repairs itself. The following Monday of Saudi Arabia’s oil explosion, the price of oil increased by an estimated 20%. After Saudi Arabia oil crisis, emerging Asian economies have suffered the most. The article also accounts how this crisis has shown the vulnerability of the oil market. Although the increase of oil prices, has negatively impacted the Global economy, the article accounts that it also had severed to be beneficial for smaller oil companies and their stocks.

Essay Overview

This essay analyses microeconomic concepts that are apparent within the article written by (McCormick et al. 2019), these concepts include how non-price determinate has shifted the supply curve for the oil market, market equilibrium, price elastic of demand, consumer and producer surplus. The analysation of these concepts are complimented with diagrams and graphs, as well as references to the main article.

Analysis

L.2 Non-price determinates shifts the supply

Supply is the positive relationship between the price of a good and the quantity supplied of the good. Economists say that when suppliers increase the quantity of supply, then the price of the good decreases and when they decrease the quantity of supply then the price of the good increases (Pearson 2015). A supply curve depicts the positive relationship between the quantity supplied of good and its price. A change to the supply curve, occurs either by a change in price or a non-price determinate (Pearson 2015).

A change in price, simply causes a movement long the supply curve (Pearson 2015).. This is illustrated in the diagram below, labelled as diagram A. The specific diagram, shows when the supplier McDonalds increases the price of a Big Mac, they have a more incentive to produce more, which contrasts to when they decrease the price, they have a less incentive to produce more.

A non-price determinate causes a shift in the curve, non-price determinates include, the prices of input such as if the cost of an input decreased than the price of product decreases (Pearson 2015). Second non-price determinate is technology, when positive technological changes occur that allow firms to produce more output with same amount in put, then the supply curve shifts to the right an example may include pre industrial revolution industries such as furniture makers would sell furniture that at the time would be considered expensive that’s because the furniture would take a lot of physical labour and time to craft, however post the industrial revolution, positive technological changes occurred that gives furniture makers the ability to make more furniture with same or less input than prior so the furnitures became cheaper and quantity supplied increased. Third non-price determinate includes the expected future prices, if a firm has an expectation that the price of a good will increase in the near future, the firm has a more incentive to reduce supply to take advantage of the future price increase, an example that illustrates this non-price determinate includes the diamond industry, firms have this expectation that the product’s price will increase in the future so they have less incentive to release full supply. The fourth non-price determinate includes number of firms in the market, when new firms enter the market supply increases which means prices decreases. Specifically, in reference to this article, it has been depicted that Saudi’s temporary stop of production, has increased the prices of oil due to the decrease of supply of oil (McCormick et al. 2019). (Safi & Wearden 2019) have estimates that Saudi’s oil production of 9.7 million barrels a day for $60 per barrel, fell to 4.7 million barrels a day due to the incident and prices increased to $72. Illustrated below in diagram B, is the shift of the supply due to the non-price determinate of reduction of supply.Market Equilibrium simply is when both price balances with the plans of buyers and sellers. Equilibrium price is the price at which the quantity demanded matches quantity supplied (Pearson 2015). Economists say that when the price is above equilibrium, it means quantity supplied is greater than quantity demanded which causes a surplus, in order to clear the surplus suppliers will reduce the price of the good. However, when the price is below the equilibrium, it means quantity demanded is greater than quantity supplied which causes a shortage, in order to clear the shortage prices will automatically rise to clear the shortage (Pearson 2015). Specifically drawing reference from the Saudi Arabia oil crisis (McCormick et al. 2019), as already mentioned oil is essential for daily usage for drivers and some industries, so demand will remain the same, so when the quantity supplied falls, prices automatically increase due to the shortage. (Krauss 2019) says that Americans use up approximation of 400 million gallons of gasoline, which a 25-cent increase would cost consumers an approximation of $100 million a day. Illustrated in Diagram C, is how the Saudi Arabi oil crisis, price being below the equilibrium creating a shortage.The term elasticity used in economics is to describe the sensitivity or responsiveness of one variable to changes in another variable (Pearson 2015). Specifically, in relation to this article (McCormick et al. 2019), price elasticity of supply is most relevant. Price elasticity of supply is most relevant as it measures the responsiveness of quantity supplied to a change in price. Due to the reduction of total production, Saudi’s oil supply decreased, and as response the oil market’s price increased by estimate of 20%. Economists say that oil is inelastic due to the necessity nature of it, people will want oil for day to day life such as for their automobiles or industries so if the prices increases, they will continue buying due to oil being considered of not having any substitutes. The market’s oil price is inelastic because consumers will buy oil regardless of how much it costs because it is considered an essential, below is an a measurement of the price elasticity of oil labelled as diagram D, the measurement was conducted using data collected from (Safi & Wearden 2019). In conclusion the measurement of the elastic of the price of oil, has concluded that oil is inelastic. Consumer surplus is equal to the difference between the buyer’s willingness to pay and the actual price paid. It measures the net benefits from consumption, if the consumer surplus increases then the consumer are “better off” (Pearson 2015). In relation to the topic of this article (McCormick et al. 2019), it is clear that the consumer surplus has been reduced due to the increase of the crude oil. (Kraussa 2019) stated that the 25% increase to oil price to American consumers’ average use of 400 million gallons a day of gasoline, can cost them $100 million a day. Below is a table attached, measuring the consumer surplus, by comparing the price consumers were paying prior week to the incident to the price they’re paying the following Monday of the incident. The consumer surplus has resulted in -12 decrease, with each barrel bought of crude oil. Also, below is diagram E attached which illustrates the consumer surplus.Producer Surplus is the price of a good minus the marginal cost of producing it (Pearson 2015). Economist have explained that higher oil price would increase the pressure on manufacturing outputs that reply on crude oil (Ambrose & Partington 2019), which will reduce their supply surplus as the marginal cost of producing may outweigh the marginal price of the good, which can reduce global economic growth. This can result in an inefficient market as both sum of consumer surplus and producer isn’t being maximised. Below diagram E is illustrates what a supply surplus is. (McCormick et al. 2019) has highlighted the vulnerability of the oil market. It is clear the lack or flaws of security has severe implications to the market that will harm the global economy, as oil is an essential commodity that is inelastic due to its capacity constraints.

A specific policy recommendation, for Saudi Arabi and other countries who participate in supplying this market in preventing an incident of this nature, is to go underground. Creating an underground facilitate for their oil processing plants, will evidently mean that non authorised personnel cannot come in close proximity to commit another incident of this nature. The idea of this recommendation was drawn from America, in the 70s the middle east caused the prices of oil to skyrocket and boycott supply from going to America due to political issues (BBC 2019). At the time the country didn’t have any barrels stored away for emergencies so it evidently felt the consequences so as a result of these events America, decided to store away oil. Saudi Arabia and other large oil distributors should consider going underground to prevent future incidents of this nature.

Another suggestion unique for Saudi Arabia, is to lessen their political tensions, an incident of this nature wouldn’t have occurred if the Kingdom didn’t have political tensions to begin with. However, it is understandable that isn’t a simple recommendation to implement.