Wednesday, June 29, 2011

Elasticity of Supply and Demand - The Market for Oil

I am routinely asked to comment for local and regional news outlets about oil and gas prices. Many in the media are often quick to blame speculators, hedge funds, and the oil company's for spikes in oil and gas prices. Yet, the cause for spikes in oil prices have far more to do with basic supply and demand. But as we recently discussed in my micro class, the key to explaining changes in oil and gas prices is the concept of elasticity.

Elasticity is a measure of the responsiveness of one variable to a change in another. In the case of demand, the elasticity of demand refers to the responsiveness of consumers (their percentage change in quantity consumed) to a percentage change in the price. In the case of supply, the elasticity of supply refers to the responsiveness of producers (their percentage change in quantity supplied) to a percentage change in the price. Oil, and one of its important byproducts, gasoline, are relatively unique in that they are very inelastic in both supply and demand, especially in the short run (most supply disruptions, political conflicts, weather, natural disasters, etc. are short term).

Yesterday, Becker and Posner both wrote about this topic in their blog. Becker's post is particularly helpful for understanding the concept of elasticity as it applies to the oil market. I recommend economic teachers take a look at this post.

Fluctuations in Oil Prices, Speculation, and Strategic Reserves-Becker 6/28/2011

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