Category: Essentials of Economics: Ch 02

Changes in the price of oil have effects throughout the economy. And it’s not just on the obvious things, such as petrol prices, energy bills and rail, bus and air fares. Most companies are significantly affected by the price of oil, as oil is a key input into their production, whether for transporting their inputs or the goods they produce, or as plastics or other petrochemicals. This is why the price of oil receives so much attention: we’re all affected by it. You will have seen the price of petrol changing dramatically over the past year or so and this is largely due to changing oil prices. The price of oil peaked at $147 a barrel in July 2008 and fell as low as $32 a barrel in December 2008.

So what is it that causes these changes in oil prices and what does it mean for the world’s economies? Read the following articles, which discuss these issues, and look at recent developments in the oil industry.

First fall in oil use since 1993 BBC News (10/6/09)
Trump’s world view Fox News, Interview between Greta van Susteren and Donald Trump (30/6/09) Oil settles above $71; China to boost reserves The Associated Press, Dirk Lammers (29/6/09)
Nigeria worries push up oil price BBC News (29/6/09)
Oil up to near $72 on dollar fall, Nigeria attack Town Hall, Pablo Gorondi (30/6/09)
Chinese demand forecast to boost oil price The Star Phoenix, Joanne Paulson (30/6/09)
Lower oil price hits Total profit BBC News (6/5/09)
Oil price hovers at $70 amid pipeline attacks Financial Times, Miles Johnson, Javier Blas, London (27/6/09)
What is going on in the oil market? BBC News (27/10/08)
Rising oil prices poses threat to recovery, Alistair Darling warns Telegraph (12/6/09)
Fears of oil crunch recede as recession knocks down global demand The Independent, Sarah Arnott (30/6/09)

Questions

  1. How is the price of oil determined? Give 2 examples of factors that could cause (a) the price of oil to increase and (b) the price of oil to decrease.
  2. How are company profits affected by the changing price of oil?
  3. OPEC is an oil cartel. What are the factors that make collusion more likely to succeed? Do they apply to OPEC?
  4. When prices of oil increase, why do we still use similar amounts of energy; still buy petrol? What’s so special about this commodity? Think about elasticity.
  5. How is the price and consumption of oil affected by the macroeconomic situation?

The global recession can be traced back to the collapse of the sub-prime mortgage market in America and so it’s hardly surprising that one of the biggest sufferers of this global crisis has been the housing market. House prices in the UK had, for some months, been in apparent free-fall, but they now appear to have stabilised. Some estate agents report prices beginning to increase, but others say they’re still falling.

Whilst lower prices should be an encouraging sign for first-time-buyers, there is another obstacle in their way. Mortgage lenders have been requiring large deposits and, unsurprisingly, have become more vigilant about whom they lend to and how much. Read the articles below that look at the crisis in the housing market and consider the impact this has had on the wider economy.

Experts far more upbeat about UK house market The Herald, Ian McConnell (26/6/09)
Gloomy CIPS data shows further woes for construction firms Construction News, Nick Whitten (2/10/08)
Construction contracts at slowest pace for seven months Construction News, Nick Whitten (5/5/09)
House prices decline again in May BBC News (26/6/09)
Mortgage lending falls back again BBC News (18/6/09)
More fixed-rate mortgages go up BBC News (16/6/09)
Housing market needs ‘feel-good factor’ to recover CityWire, Nicholas Paler (26/6/09)
Housing market set for recovery Exec Digital, Ben Lobel (26/6/09)
Home-ownership ‘aspirations hit’ BBC News (15/6/09)
House prices fall 1.7 percent in April Exec Digital (6/5/09)
Spring bounce in mortgage lending BBC News (11/6/09)
Is the first rung on the property ladder broken? BBC News, Kevin Peachey (27/4/09)
Lack of affordability may slow housing sector recovery RLA News Service (25/6/09)

See the following two sites for house price data in the UK:
Halifax House Price data from the Lloyds Banking Group
Nationwide House Price data

Questions

  1. Why has the collapse of the housing market had much wider repercussions on the UK economy? Consider the impact on construction, solicitors, surveyors.
  2. Have any groups benefited from falling house prices?
  3. How has the UK’s monetary policy in particular helped to stimulate the UK housing market? Has it been successful?
  4. Why are lenders so reluctant to lend? Is this a direct result of the sub-prime crisis in America?
  5. What is the meaning of ‘negative equity’? How does being in a situation of negative equity affect people’s behaviour?

The pound has been rising against the US dollar recently. And as the dollar has fallen, so the prices of various commodities, such as gold and silver, have been rising. So what are the reasons for these currency and commodity price movements? The simple answer is that they merely reflect changes in demand and supply. But why have demand and supply been changing? Are there changes in the underlying economic fundamentals, or do they largely reflect speculation in times of uncertainty and resulting market overcorrection? The following articles address these questions.

Sterling rises on hopes of recovery Financial Times (4/6/09)
Jeremy Warner: Dollar weakness is a sign that things are on the mend Independent (4/6/09)
Stephanie Flanders Blog: What goes down… BBC News (3/6/09)
Dollar on the rack International Business Times (1/6/09)
Sterling hits six-month high against the dollar Times Online (29/5/09)
Exchange rates: What next for the pound? This is Money (2/6/09)
Gold News BullionVault (3/6/09)
The Top 10 Reasons to Hold Gold, Bar None! The Motley Fool (2/6/09)

Questions

  1. Explain why the pound been rising strongly against the dollar.
  2. What is likely to happen to the exchange rate of the pound against the dollar and the euro over the next few months?
  3. If it were possible to predict the future exchange rate today, what would happen to the exchange rate today?
  4. Why might it be a good time to buy gold? Why might it be too late?

In an earlier news item we saw that the global recession has hit the demand for organic produce. The same is not true for Fairtrade products as a global survey published on 17/4/09 shows (see). Awareness of Fairtrade products continues to grow as do sales. The articles below look at the findings of this survey and at the explanations behind it.

UK: Fairtrade Flows Against Economic Tide Namnews (20/4/09)
The government must act on fair trade now Public Service Review: International Development Issue 13 (20/4/09)
Fairtrade a hit with shoppers as demand rises despite credit crunch Glasgow Daily Record (17/4/09)
Link to short videos from the Fairtrade Foundation; Link to facts and figures on Fairtrade Fairtrade Foundation

Questions

  1. Consider the reasons why Fairtrade sales have increased while sales of organic produce have declined.
  2. Does purchasing Fairtrade products mean that consumers are not seeking to maximise their consumer surplus?
  3. What economic challenges face Fairtrade producers? How should governments help the Fairtrade movement?
  4. Is the liberalisation of trade in the interests of Fairtrade producers?

The recession of the past few months has taken its toll on organic farmers. Until recently, the industry was booming as consumers switched to products perceived as greener, healthier and more ethically produced. Now, as many consumers are feeling the pinch, they are switching to cheaper foodstuffs. The resulting decline in demand for organic food has turned profit into loss for many organic farmers. According to the first of the linked articles below, at least two organic farmers are leaving the movement each week.

But what will happen as the economy recovers and people start turning back to organic products? Given that it takes some two years to convert to organic standards, there could be supply shortages next year.

As UK shoppers tighten their belts, organic farmers feel the squeeze Guardian (11/4/09)
United Kingdom-Organic slowdown Farming UK (12/4/09)
Can the organics survive the current economy? Limerick Post (10/4/09)

Questions

  1. How close to perfect competition is the market for organic foods?
  2. What determines whether an organic farmer should continue in the market even though a loss is being made?
  3. What can you conclude about the income and price elasticities of demand for organic produce and the cross-price elasticity of demand for organic food with eating out?
  4. What is likely to happen to the market for organic food over the next two years?