Price Control on Oil Prices?

Elasticity is the measure of responsiveness of a market to a price change. It measures how much the quantity demanded or supplied changes, as a responds to a price change. Inelastic demand is when the market has a very little change when the prices change. Inflation is the rise in the general level of prices of goods and services in a given economy over a period of time.

Oil supplies are to a large extent controlled by OPEC, as the main oil resource exporters in the world; OPEC controls most of the world's oil supply levels. OPEC keeps the oil supplies the same in a world with increasing economic growth therefore "supplies are not keeping pace with robust global demand". Oil suppliers producing at stable output levels whilst confronted with higher consumption because of the economics growth create a somewhat inelastic supply curve . This results in a market with high oil prices and oil, as an even scarcer product with a more inelastic supply as already existed .

Higher inflation struck, because of higher oil prices, while the U.S. economy was in boom with large economic growth. Demand did not decrease showing a very inelastic demand. Higher inflation in general means that everyone (industries and consumers) is confronted with higher costs that should theoretically impact oil demand. Oil being a commodity good with inelastic demand showed the little impact of the increased prices. The economy was booming at the same time, with steady supplies a shortage could be created.

The Federal Reserve normally controlling high inflation rates also affects Price levels. They try preventing high inflation rate and higher costs, as this can lead to economic instability. The Federal Reserve Bank uses its monetary policy to lower the inflation as much as possible. The policy usually increases interest rates, making the lending of money needed for economic growth more expensive and as a result leads to the cooling of the economy. This should result in lower oil demand and decreases the elasticity to a more elastic demand. The decrease in demand would then lower the oil prices, and make sure no shortage can occur.

However this did not happen as "The Fed cut its benchmark federal funds rate overnight by half a percentage point to 4.75 percent". So the Fed has decreased, the interest rates instead of the expected increase. This was because the Federal Bank faced a dilemma, the "credit crunch" which was "hurting the overall economy"; consumers who couldn't pay back their debts to banks created the credit crunch. In order to lower these debts the interest rates had to be decreased. The U.S. economy therefore continued the economic growth; the interest rate decreasing also spurred more investment.

'The unexpected half-point cut spurred even more buying" creating a shift in demand, and consequently the oil prices rose because supplies couldn't keep up with the inelastic demand. The demand being high, with a scarce supply means the market has a shortage with the supply producing at the old equilibrium but the demand buying at the new equilibrium with a higher quantity.

OPEC had to change the amount of oil produced because "supplies are not keeping pace with robust global demand'. "Last week prices rose despite OPEC's decision to boost production by 500,000 barrels a day. OPEC being the cause of the inelastic supply was the only one who could stop the prices from rising due to the shortage. These prices wouldn't have risen if the demand were elastic, consumers switching to substitute products. Inelastic supply and demand show how the monopoly of the scarce oil, can affect the entire global economy. On the graph below it can be seen that the supply increase from 'E' to 'E2' got rid of the main shortage, having a higher quantity than the demanded quantity Q1. Even though the market has the same price as the old equilibrium price, the quantity has increased to a higher quantity, due to economic growth

The shifts of the inelastic demand and supply (as kept inelastic by the OPEC) have caused inflated oil prices. This combined with consumer expectations and the Federal Reserve interest rate cut have continued rising prices. The weak dollar further increases the demand as they promote foreign investors to invest, created higher levels of inflation.

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