Lecture Issues in economics today - Chapter 39

The main contents of this chapter include all of the following: Financing international trade, the balance of payments, exchange rate systems, globalization of the U.S. dollar, growing foreign ownership of american assets.

Chapter 39 Energy Prices   McGraw­Hill/Irwin   © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved Chapter Outline • • • • •   HISTORICAL VIEW OPEC WHY PRICES CHANGE SO FAST WHAT WILL THE FUTURE HOLD Electricity Prices McGraw­Hill/Irwin   © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved Real Oil and Ga per gallon (1 barrel=42 2.5 $ 1.5 0.5 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 year Real Gas Price Real Domestic RealCrude Import C   McGraw­Hill/Irwin   © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved Historical Events Relating to Oil and Gas Prices • 1972 Arab-Israeli War – US support for Israel prompted an embargo by Arab oil producers against the US and Europe This led to a significant increase in crude oil prices • 1979 Iranian Revolution – Iran’s Islamic revolution led to instability in the Persian Gulf This led to a significant increase in crude oil prices • 1980’s – Rapid increases in profits led to significant discoveries of oil in Mexico and the North Sea • 1980-1988 Iran-Iraq War   – The war led to increased production by both parties as each needed to fund their war effort This caused a precipitous fall in crude oil prices McGraw­Hill/Irwin   © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved World Oil Reserves Group Billions of Barrels Percentage of in Reserve World Reserves Persian Gulf 664 63% Non-Persian Gulf OPEC 134 13% Rest of the World 238 24% McGrawưHill/Irwin â2002TheMcGrawưHillCompanies,Inc.,AllRightsReserved OPEC The Organization of Petroleum Exporting Countries (OPEC) – Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, United Arab Emirates, and Venezuela • OPEC began as a cartel – A cartel is an organization of individual competitors that join to form as a single monopolist   McGraw­Hill/Irwin   © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved th o u s a n d b a r e ls a d Was OPEC a Cartel? Oil Production World, Non-OPEC and 70000 60000 World 50000 40000 Non-Op 30000 20000 Opec 10000 1970197519801985199019952000 Year OPEC production has always been a significant part of the oil market  but it has never reached the level of monopoly. The cartel model is still  useful because it has been a dominant player     McGraw­Hill/Irwin © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved The Cartel Model Market for Oil P P One Country’s Oil MC S=MC ATC Profit Profit MR’ Pcartel PPC MR D Qcartel   McGraw­Hill/Irwin MR QPC Q   Qquota QPC Qcheat Q © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved Why Oil and Gas Prices Change So Fast • Because expected price is a determinant of supply and demand a world event that causes people to expect a price increase will – Increase current demand (as middlemen and consumers try to buy as much as possible) – Decrease current supply (as middlemen and gas stations try to hold onto their current stocks) • This causes an immediate increase in prices   McGrawưHill/Irwin â2002TheMcGrawưHillCompanies,Inc.,AllRightsReserved Electricity Residential electric power tends to be sold by a regulated monopoly • It has been a monopoly because of significant barriers to entry • It has been regulated because prices would be much higher than is socially optimal   McGraw­Hill/Irwin   © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved Types of Monopolies • Simple Monopoly: a monopoly in which marginal costs of production are rising • Natural Monopoly: a monopoly in which marginal costs of production are falling   McGraw­Hill/Irwin   © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved Monopoly in the Market for Residential Electricity • The market for residential electricity is likely to be a natural monopoly for nuclear power because of the very high fixed costs (transmission lines and the power plant and diminishing marginal costs.) • The market may be characterized as a simple monopoly or natural monopoly for coal or gas generated electricity   McGraw­Hill/Irwin   © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved An Unregulated Simple Monopoly MCMonopoly P Pmonopoly MR Qmonopoly   McGraw­Hill/Irwin D Q   © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved An Unregulated Natural Monopoly P Pmonopoly D MR Qmonopoly   McGraw­Hill/Irwin   ATC MCMonopoly Q © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved An Regulated Simple Monopoly MCMonopoly P Pmonopoly Pregulated MR Qmonopoly Qregulated   McGraw­Hill/Irwin   D Q © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved An Regulated Natural Monopoly P Pmonopoly D Pregulated MR Qmonopoly   McGraw­Hill/Irwin   Qregulated ATC MCMonopoly Q © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved The California Experience • California produces electricity with natural gas • California “deregulated” by – Having its utilities sell their productive capacity to a variety of competitive producing firms – Having them buy electricity from these producers – Letting the market price for wholesale electricity float – Continuing to fix residential electricity prices • Natural gas prices increased dramatically • The utilities could not buy the power because they were selling it at regulated prices that were lower that the deregulated prices at which they were buying it   McGraw­Hill/Irwin   © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved  ... significant increase in crude oil prices • 1980’s – Rapid increases in profits led to significant discoveries of oil in Mexico and the North Sea • 198 0-1 988 Iran-Iraq War   – The war led to increased... Natural Monopoly: a monopoly in which marginal costs of production are falling   McGraw­Hill/Irwin â2002TheMcGrawưHillCompanies,Inc.,AllRightsReserved Monopoly in the Market for Residential... McGraw­Hill/Irwin   © 2002 The McGraw­Hill Companies, Inc., All Rights Reserved Types of Monopolies • Simple Monopoly: a monopoly in which marginal costs of production are rising • Natural Monopoly: