The Oil Industry

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The Oil Industry

• Melissa Metcalf, Colin Peck,
• Joshua Prescott
• ECN 101
• Washington Jefferson College

2
Table of Contents

• Josh
• Economics The Science of Choice
• Factors of Production
• Opportunity Cost
• Supply

3
Table of Contents Cont.

• Colin
• Demand
• Elasticity of Demand
• Law of Diminishing Marginal Utility
• Law of Diminishing Marginal Returns

4
Table of Contents Cont.

• Melissa
• Profit
• Perfect Competition
• Monopoly
• Oligopoly

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Economics The Science of Choice

• Economics is that social science which studies
  the way society chooses to allocate its scarce
  resources in order to satisfy unlimited wants and
  needs.

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Economics The Science of Choice

• How does this apply to the Oil Industry?
• Economics applies to most of what happens in
  the Oil Industry since oil is one of the scarce
  natural resources that our society heavily relies
  upon. Principles such as those behind the
  recently elevated oil prices are deeply rooted in
  Economics.

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Factors of Production

• Land
• The land that the company headquarters, oil
  wells, refineries, and distributors occupy.
• Labor
• Labor of employees to discover, drill for,
  refine, and distribute oil.
• Capital
• Wells, machinery, refineries, technology, and
  skills of employees.
• Entrepreneurial Activity
• Competition in the oil industry promotes
  discovery of new and innovative ways to refine
  and distribute oil.

8
Opportunity Cost

• The opportunity cost of pursuing new projects
  such as new oil wells is not only the money that
  would have otherwise been allocated to spending
  on different goods and/or services, but also the
  value of the next best alternative.

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Opportunity Cost
Opportunity Cost Explicit Costs Implicit Costs

• Explicit Costs
• Cost of Land
• Cost of Equipment and Maintenance of Equipment
• Cost of Labor
• Implicit Costs
• Value of the next best alternative.

10
Supply and Demand

• Always remember that a change in price of an
  item will NEVER cause a change in the Demand or
  Supply curve. It may cause a change in the
  quantity demanded/supplied of the item.
• -Dr. Gregor

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Supply

• What exactly is supply?
• Supply is a relationship showing the various
  amounts of an item that sellers are willing and
  able to make available for sale at various
  possible alternative prices, during a given
  period of time.
• Ceteris Paribus - INEPT

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Supply Continued

• Input Prices
• The skilled labor and complex machines used in
  oil production are extremely costly.
• Number of Sellers
• There are relatively few production companies in
  the oil industry compared to other industries.
  Thus, the oil companies have more control over
  the prices of their products.
• Expectation of Sellers
• Sellers have different expectations in different
  environments especially with respect to prices.
  For example, the fluctuation in oil consumption
  in Pittsburgh throughout the year.

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Supply Continued

• Prices of Alternative Goods
• The prices and profitability of alternate goods
  that a firm in the oil industry could produce
  using some of the same types of inputs as the
  good in question.
• Technology
• A technological advance in production will allow
  a firm to produce oil at a given level of output
  in a new and less costly way than before.

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Demand

• What exactly is Demand?
• Demand is a relationship showing the various
  amounts of an item which buyers are willing and
  able to purchase at various possible alternative
  prices, during a given period of time.
• Ceteris Paribus - INEPT

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Demand Continued

• Income
• As income increases, then consumers are
  increasingly more willing and able to buy more
  oil products since oil can be considered a normal
  good.
• Number of Consumers
• The number of consumers in the market for heating
  oil fluctuates from season to season. However,
  there are billions of people in the market for
  oil all year round since the automobiles our
  society has come to depend upon need motor oil
  and gasoline in order to run.

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Demand Continued

• Expectations of buyers
• Different environments, price changes, and
  availability.
• Prices of related goods
• Substitutes Prices of oil products differ from
  prices of competing goods such as Natural Gas and
  Electricity.
• Complements The prices of appliances that use
  heating oil instead of natural gas to heat homes
  as well as the prices of automobiles and other
  machines with gasoline or diesel engines can
  influence the demand for oil products as they may
  rise and fall.

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Demand Continued

• Tastes
• Often buyers are influenced by what they simply
  prefer. It is possible that some consumers in the
  market for energy actually prefer oil products to
  alternative products such as natural gas and
  electricity.

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Elasticity of Demand

• The price elasticity of demand for a good is the
  percentage change in the quantity demanded
  divided by the percentage change in price
• ED ?QD / ?P.

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Elasticity of Demand

• The short-run elasticity of demand for oil is
• -0.15. This means that in the short-run, the
  demand for oil is very inelastic.
• One would assume that when the price of a oil
  rises, the demand decreases, and vice-versa.
  However, in this case we find that even though
  there are some exceptions the demand for oil
  remains pretty constant.

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Law of Diminishing Marginal Utility

• The marginal utility of oil products to anyone
  diminishes with every increase in the amount of
  them he/she consumes.

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Law of Diminishing Marginal Utility

• Marginal Utility is the change in total utility
  an individual obtains from consuming an
  additional unit of a good or service
• MU ?TU/?Q

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Law of Diminishing Returns

• The law of diminishing returns is a physical law,
  not an economic one. It is based on the nature
  of productionon the physical relationship
  between inputs and outputs with a given
  technology.

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Law of Diminishing Returns

• As we continue to add more of any one input (ex
  labor) (holding all other inputs constant), its
  marginal product will eventually decline

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Profit

• Two Definitions of Profit
• Accounting Profit Total Revenue Accounting
  Costs.
• This will suffice for Accountants, but Economists
  have a much broader view of cost.
• Economic Profit Total Revenue All costs of
  production (Explicit Costs Implicit Costs).
• The difference between Accounting Profit and
  Economic Profit is an important one Accounting
  Profit is the profit on the books, and Economic
  Profit is a more accurate measure of true
  profit.

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Perfect Competition

• Three Characteristics of Perfectly Competitive
  Firms
• Are there a large number of buyers and sellers in
  the oil market?
• NO!
• Are the products produced by different oil
  companies considered homogenous?
• YES!
• Is there easy entrance and/or exit from the oil
  market?
• NO!
• Is the Oil Industry Perfectly Competitive?
• NO!!!

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Monopoly

• A Monopoly Firm is the only seller of a good or
  service with no close substitutes. The market in
  which the monopoly firm operates is called a
  Monopoly Market.
• In the Oil Industry, do the companies produce
  close substitutes?
• YES!
• Are there any monopolies in the Oil Industry?
• NO!

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Oligopoly

• An oligopoly is a market structure in which a
  small number of firms are strategically
  interdependent.
• Does the oil industry form an oligopoly?
• Yes, it does. The individual companies are
  strategically interdependent even though they are
  in competition with one another.
• Why? / Why not?
• Strategic Barriers, Government Created Barriers,
  and Reputation Barriers exist.

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THATS ALL FOLKS!
Melissa Metcalf Colin Peck Joshua Prescott
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