The Economics of Oil

The first thing to realize about oil is that it is a fungible commodity. All this means is that the price of oil is the same no matter where it is traded in the world. As a result anything that effects the supply or the demand for oil anywhere in the world will predictably affect the price of oil. Therefore, for oil the laws of supply and demand are universal. So if we understand the laws of supply and demand we can easily see how policy will effect how and how much we use of it. So let’s look at the laws of supply and demand. There are two.

The first law of supply and demand says that price is proportional to demand and inversely proportional to supply.

P ~ D/S

This is just common sense. The more people want something, the more they are willing to pay for it. Conversely the more readily available something is, the cheaper it will be. Whenever, we hear about the price of oil we hear about factors of supply and demand that are effecting it. The latest manifestation of this is, prices are high because the summer driving season is coming up (increase demand) and there is uncertainty in Nigeria and Iran (decrease supply). Note: factors in the North America coupled with factors in Africa and Southwest Asia affect the world price of oil because it is fungible.

The second law of supply and demand says that demand is inversely proportional to price.

D ~1/P

Again, this is just common sense. The more expensive something is the less likely people will buy it. Conversely, the cheaper is is the more people will be willing to buy it.

Using these very basic economic laws we can see what how effective the proposed energy solutions really are.