Oil prices will remain below $60 per barrel for the foreseeable future. At least this is what is being assumed by most oil producing companies. In the more distant future, prices may rise as investment in fracking, tar sands and new wells dries up. In meantime, however, marginal costs are sufficiently low as to make it economically viable to continue extracting oil from most sources at current prices.
The low prices are partly the result of increases in supply from large-scale investment in new sources of oil over the past few years and increased output by OPEC. They are also partly the result of falling demand from China.
But are low prices all bad news for the oil industry? It depends on the sector of the industry. Extraction and exploration may be having a hard time; but downstream, the refining, petrochemicals, distribution and retail sectors are benefiting from the lower costs of crude oil. For the big integrated oil companies, such as BP, the overall effect may not be as detrimental as the profits from oil production suggest.
BP – low oil price isn’t all bad new BBC News, Kamal Ahmed (27/10/15)
Want to See Who’s Happy About Low Oil Prices? Look at Refiners Bloomberg, Dan Murtaugh (31/10/15)
Low prices are crushing Canada’s oil sands industry. Shell’s the latest casualty. Vox, Brad Plumer (28/10/15)
Brent spot crude oil prices US Energy Information Administration
BP Quarterly results and webcast BP
- Why have oil prices fallen?
- What is likely to happen to the supply of oil (a) over the next three years; (b) in the longer term?
- Draw a diagram with average and marginal costs and revenue to show why it may be profitable to continue producing oil in the short run at $50 per barrel. Why may it not be profitable to invest in new sources of supply if the price remains at current levels?
- Find out in what downstream sectors BP is involved and what has happened to its profits in these sectors.
- Draw a diagram with average and marginal costs and revenue to show why profits may be increasing from the wholesaling of petrol and diesel to filling stations.
- How is price elasticity of demand relevant to the profitablity of downstream sectors in the context of falling costs?
Ever been to the cinema and found it almost empty? And then wondered why you paid the full price? Perhaps you’ve taken advantage of Orange Wednesday or only go if there’s a particularly good film on? Often it might be cheaper to wait until the film is out on DVD!
Going to the cinema can be an expensive outing. The ticket, the popcorm, a drink, ice cream – it all adds up! Orange Wednesday has recently disappeared and this will definitely have an impact on consumption of movies at your local Odeon, Vue or Showcase. The impact will be on how many seats are left empty.
However, a new app could be set to generate revenues for the cinema and provide cheaper entertainment for your everyday consumer. This new app will allow cinemas to send out alerts to people in the local area advising them that a screening will have many empty seats. What’s the incentive? Perhaps a discount, or some food. But, why would they do such a thing?
If a movie is being shown at a cinema, there will be a large fixed cost. However, what happens as each additional consumer enters the theatre? Does the cost to the cinema rise? Perhaps there is a small cost with more cleaning required, but the additional cost of actually showing the film if there 11 rather than 10 people is almost (if not equal to) zero. That is, the marginal cost of an extra user is zero. Therefore, if there is a screening with many empty seats, wouldn’t the cinema be better to offer the seats for half price. After all, if you can earn £5 from selling a ticket and the additional cost is almost zero, then it’s better to sell it for £5 than not sell it for £10! The following article and video from BBC News considers this new app and other strategies to maximise cinema usage!
Apps in pockets, bums on cinema seats BBC News, Dave Lee (27/2/15)
- What would the budget constraint look like for a cinema where a discount was offered if you purchased two cinema tickets and then received the third ticket for half price?
- Why is the marginal cost of an extra user at the cinema almost zero?
- If the MC = 0, does this mean that a cinema is a public good?
- How will this new app allow a cinema to increase total revenue and profit?
- If it is cheaper to buy a DVD rather than go to a cinema, why do people still go to the cinema?
There have been two significant changes in prices for travel in Bristol. At the end of April, the toll on Brunel’s iconic Clifton Suspension Bridge doubled from 50p to £1 for a single crossing by car. The bridge over the Avon Gorge links North Somerset with the Clifton area of Bristol and is a major access route to the north west of the city. Avoiding the bridge could add around 2 miles or 8 minutes to a journey from North Somerset to Clifton.
The justification given by the Clifton Suspension Bridge Trust for the increase was that extra revenue was needed for maintenance and repair. As Trust Chairman Chris Booy said, ‘The higher toll will enable the Trust to continue its £9 million 10-year vital repair and maintenance programme which aims to secure the bridge’s long-term future as a key traffic route, one of Bristol’s major tourist destinations and the icon of the city’.
The other price change has been downwards. In November 2013, the First Group cut bus fares in Bristol and surrounding areas. Single fares for up to three miles were cut from £2.90 to £1.50; 30% discounts were introduced for those aged 16 to 21; half-price tickets were introduced for children from 5 to 15; and the two fare zones for £4 and £6 day tickets were substantially increased in size.
First hoped that the anticipated increase in passengers would lead to an increase in revenue. Evidence so far is that passenger numbers have increased, with journeys rising by some 15%. Part of this is due to other factors, such as extra bus services, new buses, free wifi and refurbished bus stops with larger shelters and seats. But the company attributes a 9% rise in passengers to the fare reductions. As far as revenue is concerned, indications from the company are that, after an initial fall, revenue has risen back to levels earned before the fare reduction.
What are the longer-term implications for revenue and profit of these two decisions? This depends on the price elasticity of demand and on changes in costs. Read the articles and then consider the implications by having a go at answering the questions.
Clifton Suspension Bridge toll to rise from 50p to £1 BBC News (9/4/14)
Regular Users of Clifton Suspension Bridge will be Protected from the Increase in the Bridge Toll Clifton Suspension Bridge (9/4/14)
Clifton Suspension Bridge Review Decision Letter Department of Transport (24/3/14)
Clifton Suspension Bridge Trust: bridge toll review inspector’s report Department of Transport (8/4/14)
Clifton Suspension Bridge Toll Increase – Account of the May 2013 Public Inquiry The National Alliance Against Tolls (NAAT)
First Bus Bristol fare cuts sees passenger growth BBC News (6/6/14)
First gamble over cheaper bus fares pays off as passengers increase in Bristol The Bristol Post (6/6/14)
Bristol bus fares deal to extend to South Gloucestershire and North Somerset The Bristol Post, Gavin Thompson (12/6/14)
- What assumptions is the Clifton Suspension Bridge Trust making about the price elasticity of demand for bridge crossings?
- What determines the price elasticity for bridge crossings in general? Why is this likely to differ from one bridge to another?
- How is the long-term price elasticity of demand likely to differ from the short-term elasticity for Clifton Suspension Bridge crossings and what implications will this have for revenues, costs and profit?
- How is the price elasticity of demand for the bridge likely to vary from one user to another?
- How is offering substantial price reductions for multiple-crossing cards likely to affect revenue?
- What determines the price elasticity of demand for bus travel?
- What could a local council do to encourage people to use buses?
- How is the long-term price elasticity of demand for bus travel likely to differ from the short-term elasticity?
- In the long run, is First likely to see profits increase from its fare reduction policy? Explain what will determine this likelihood.
Profits are maximised where marginal cost equals marginal revenue. And in a perfectly competitive market, where price equals marginal revenue, profits are maximised where marginal cost equals price. But what if marginal cost equals zero? Should the competitive profit-maximising firm give the product away? Or is there simply no opportunity for making a profit when there is a high degree of competition?
This is the dilemma considered in the articles linked below. According to Jeremy Rifkin, what we are seeing is the development of technologies that have indeed pushed marginal cost to zero, or close to it, in a large number of sectors of the economy. For example, information can be distributed over the Internet at little or no cost, other than the time of the distributor who is often willing to do this freely in a spirit of sharing. What many people are becoming, says Rifkin, are ‘prosumers’: producing, sharing and consuming.
Over the past decade millions of consumers have become prosumers, producing and sharing music, videos, news, and knowledge at near-zero marginal cost and nearly for free, shrinking revenues in the music, newspaper and book-publishing industries.
What was once confined to a limited number of industries – music, photography, news, publishing and entertainment – is now spreading.
A new economic paradigm – the collaborative commons – has leaped onto the world stage as a powerful challenger to the capitalist market.
A growing legion of prosumers is producing and sharing information, not only knowledge, news and entertainment, but also renewable energy, 3D printed products and online college courses at near-zero marginal cost on the collaborative commons. They are even sharing cars, homes, clothes and tools, entirely bypassing the conventional capitalist market.
So is a collaborative commons a new paradigm that can replace capitalism in a large number of sectors? Are we gradually becoming sharers? And elsewhere, are we becoming swappers?
Capitalism is making way for the age of free The Guardian, Jeremy Rifkin (31/3/14)
The End of the Capitalist Era, and What Comes Next Huffington Post, Jeremy Rifkin (1/4/14)
Has the Post-Capitalist Economy Finally Arrived? Working Knowledge, James Heskett (2/4/14)
- In what aspects of your life are you a prosumer? Is this type of behaviour typical of what has always gone on in families and society?
- If marginal cost is zero, why may average cost be well above zero? Illustrate with a diagram.
- Could a monopolist make a profit if marginal cost was zero? Again, illustrate with a diagram.
- Is it desirable for there to be temporary monopoly profits for inventors of new products and services?
- What is meant by a ‘collaborative commons’? Do you participate in such a commons and, if so, how and why?
- Should tweets and Facebook posts be regarded as output?
- What is meant by an internet-of-things infrastructure?
- What are the incentives for authors to contribute to Wikipedia?
- Could marginal cost ever be zero for new physical products?
- Think about the things you buy in the supermarket. Could any of these be produced at zero marginal cost?
- How can capitalists make profits as ‘aggregators of network services and solutions’?
- Provide a critique of Rifkin’s arguments.
‘Farm-gate’ milk prices (the price paid to farmers) have been rising in the UK. In July they reached a record high of 31.4p per litre (ppl). This was 5.1ppl higher than in July 2012. There were further price rises this month (October). Sainsbury’s increased the price it pays farmers by nearly 2ppl to 34.15ppl and Arla Foods by 1.5ppl to 33.13ppl. Muller Wiseman is set to raise the price it pays to 32.5p per litre.
And yet many farmers are struggling to make a profit from milk production, claiming that their costs have risen faster than the prices they receive. Feed costs, for example, have risen by 2.12ppl. On average, farmers would need over 38p per litre just to cover their average variable costs. What is more, exceptional weather has reduced yields per cow by some 7%.
Meanwhile, in the USA, supply has risen by some 1.3% compared with a year ago. But despite this, the prices of dairy products are rising, thanks to strong demand. Cheese and butter prices, in particular, are rising rapidly, partly because of high demand from overseas. Demand for imported dairy products is particularly high in China, where supply has fallen by some 6% in the past couple of months.
The problem for dairy farmers in the UK is partly one of the power balance in the industry. Farmers have little or no market power. Supermarkets, however, have considerable market power. As large oligopsonistic buyers, they can put downward pressure on the prices paid to their suppliers. These are mainly large processing firms, such as Robert Wiseman Dairies, Arla Foods and Dairy Crest. They, in turn, can use their market power to keep down the price they pay to farmers.
Dairy farmers renew protests over milk prices Farmers Weekly, Philip Case (5/9/13)
Dairy farmers ‘lost more than 1p/litre last year’ Farmers Weekly, Philip Case (2/10/13)
South West farming businesses and producers still making a loss on milk South West Business (3/10/13)
Q&A: Milk prices row and how the system works BBC News (23/7/12) (note date of this)
Positive Dairy Trend: Rising Milk Production and Strong Demand The Farmer’s Exchange, Lee Mielke (27/9/13)
Chinese supply crisis to delay dairy price adjustment Rabobank (25/9/13)
China milk ‘crisis’ fuels world dairy price rise Agrimoney (1/10/13)
UK milk prices and composition of milk ONS
Combined IFCN world milk price indicator IFCN
- Give some examples of (a) variable costs and (b) fixed costs in milk production.
- Why may farmers continue in dairy production, at least for a time, even if they are not covering their average variable costs?
- What factors determine (a) the price of milk paid to farmers; (b) the retail price in supermarkets?
- Explain how dairy futures markets work.
- Could the milk processors use their market power in the interests of farmers? Is it in the interests of milk processors to do so?
- Why is there a Chinese “dairy supply crisis”? What is its impact on the rest of the world? What is the relevance of the price elasticity of demand for dairy products in China to this impact?