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Summary of article

There are some reasons that lead to the price of crude oil dropped statisticallyin the
article such as the slowdown in Chinese demand, growing crude oil supplies, cheaper
price of gasoline, Organization of the Petroleum Exporting Countries(OPEC) and Iran
nuclear deal. In article said that the U.S oil and Brent, the global oil benchmark settled
down 5.5%, at $38.24 a barrel on the New York Mercantile Exchange and 6.1%, at
$42.69 barrel on ICE futures Europe respectively. The demand of crude oil decreased
lead to prices tanked overnight following an 8.5% decline on Shanghai Composite Index.
So China has become the dominant concern and took over as the main driver of oil
prices. Furthermore, an increase the crude oil supplies in Cushing, Okla., would likely
further weigh on U.S oil prices. As a substitute, the price of crude oil dropped because
consumer switch to demand cheaper price of gasoline. The OPEC continue to robust the
crude oil production despite prices had a large drop in the past year. Lastly, if sanctions
on country’s oil exports are approved, Iran will increase the output of crude oil at any
cost said by Iranian Oil Minister Bijan Zanganeh.

Microeconomic concepts
First of all, one of the microeconomic concepts related to the article that I choose is the
law of demand. The definition of law of demand is the price of a product has an inverse
relationship to the quantity of the product demanded (Hubbard) and the demand curve is
downward slopping. In situation of ceteris paribus, when the price of a product falls, the
quantity demanded of the product will increases vice versa. In diagram, demand curve
will shift inwards or outwards due to different variables and effects such as income
effect, substitute effect, population and demographics and expected futures prices
(Hubbard). For instance, when there is a decrease in price of apple, consumers have more
incentive to purchase apple so the demand of apple increase. In the article, there are
showing that demand of crude oil decrease in China, therefore the price of crude oil
dropped (Friedman). This is because the economy in China slows down compare to past
few years and government devaluated their currency (Tarver). The purchasing power of
consumers and the income of citizen decreased in China. Due to income effect, when
income of consumers falls, the demand of crude oil decreases. With China being the
world’s largest oil importer, this is a huge impact on global demand of crude oil. In
diagram 1 below, the demand curve shifted inwards from DD1 to DD2, so the quantity
demanded decreases from Q1 to Q2 and the price falls from P1 to P2. Therefore, one of
the reasons that price of crude oil dropped is because the quantity demanded decreased in
the world.
SS1

PricP2

Crude oil

P1

Diagram

P2
DD1
DD2
Q

Q
1

Quantity

On the other hand, the second microeconomic concept that involved in the article is
cross-price elasticity of demand. Cross-price elasticity of demand which is the percentage
change in quantity demanded of one good divided by the percentage change in price of
another good (Hubbard). When cross- price elasticity of demand is positive sign, it
represents the two products are substitute. If the two products are complements then the
cross-price of demand will be negative sign and two products are unrelated, it will be
zero. For example, vehicles and tyres are complements, so when the price of tyres
decrease, the demand of vehicles will be increased. In the article, there shown that
consumers benefit form cheaper gasoline and heating oil (Friedman). We know that
gasoline and crude oil are substitutes, therefore consumers are sensitive to the price
changes of the two goods. When there is a decrease in price of gasoline, it means that the
price of crude oil is higher than gasoline, so consumers will switch to demand on
gasoline. This will lead to a fall on demand of crude oil. The price of crude oil will drop
since the demand decrease due to substitution effect in the law of demand. The
substitution effects refer to the change in the quantity demand of a good results from a
change in price making the relative to other goods that are substitutes. In this situation,
here has two diagrams below to show the changes demand and the price. In diagram 2,
the diagram shows the demand of gasoline increase due to cheaper price, so demand
curve shifted outwards from DD0 to DD1 and the quantity demanded increase.However,
the price of the gasoline will increase back in the long term.Otherwise, in diagram 3, the
diagram shows the demand of crude oil decrease because the price of gasoline as a
substitute falls. The demand curve of crude oil shifted inwards from DD1 to DD2 and the
quantity demanded reduce. So that price of crude oil gets lower.

Price

Pric

SS0

SS

P
P2

P
DD

P2

DD
Q

Q

Gasoline
Diagram

Quantity

DD
Q2

Q1

DD
Quantity

Crude oil
Diagra

Not only that, price floor is the third microeconomic concept that related to the article.
Price floor which is a legally determined minimum price that sellers may receive
(Hubbard). Price floor is one of the government interventions. In usually, government

will impose price floor on agricultural markets and labor market. When there is a price
floor, it involves consumer surplus, producer surplus and deadweight loss. Consumer
surplus is the difference between the highest price a consumer is willing to pay for a
good or service and the actual price that consumer pays (Hubbard). Consumer surplus
measures of the benefits that people gain from purchasing goods and services
(Beta.tutor2u.net). Producer surplus is a measure of producer benefits and also the
difference between what producers are willing and able to supply a good for and the
price they actually receive (Beta.tutor2u.net). The definition of deadweight loss is the
costs to society created by market inefficiency. It occurs when supply and demand is not
in equilibrium. In article, there said that Brent settled down $2.77, or 6.1%, at $42.69 a
barrel on ICE Futures Europe, this was the lowest settlement since March 2009
(Friedman). The global oil benchmark is a price floor and it gets settled down, so the
price of crude oil decreases.

SS
Price floor
1
Price floor
2

Pric
P1
P2
P0

Q1

Q

Q

Q2

DD
0
Quantity

Q0
Crude oil
Diagra

In the diagram 4, market equilibrium is at price P0, and quantity demanded Q0. When
Brent settled down the crude oil’s price floor from P1 to P2. The quantity demanded
decrease from Q2 to Q4 and the quantity supplied increase from Q1 to Q3. According to
diagram above, so we can conclude that the price of crude oil falls, demand decrease and
supplies increase. In this situation, the consumer surplus increase [(P1-P2) x Q1], it is
because the people can purchase cheaper price of crude oil. The producer surplus
decrease [(P1-P2) x Q1] because the profits of the producers dropped from decreasing in
demand and price. Deadweight loss of the diagram also smaller.

Issue and diagram
Next, in the article showsthat Iran oil minister Bijan Zanganeh said if sanctions on the
country’s oil exports are approved, Iran will increase its output at any cost(Friedman).
We know that Iran is one of the main country exporting crude oil, so if they increase the

output of crude oil, the price will drop in the global market. This is related to law of
supply, it refers to increase in price cause increase in the quantity supplied vice versa in
ceteris paribus and supply curve is to be upward slopping (Hubbard). There are some
variables that shift market supply such as price of inputs, technological change, prices of
substitutes in production, expected futures prices and number of firms in the market
(Netmba.com). According to the article, the supply of the crude oil increase lead to the
price reduce. The supply curve shifted outwards in the demand and supply diagram.
SS

Pric
e

SS
1

P0
P1

Q0 Q1

DD
0
Quantity

Crude oil
Diagra

On the diagram above, we can see that the quantity supplied increase from Q0 to Q1 and
the price reduce from P0 to P1. Then when the crude oil is oversupply in the global
market, the price of crude oil will drop and this has been reflected on the real world.