Appendix 15.

3 A worked numerical example

Let us take 1990 as the ‘initial year’ of the study. In 1990, the oil price was P0 = $20 per barrel, and

oil output was R0 = 21.7 billion barrels. From our demand function (equation 15.8)

P0 = Ke–aR0

we obtain

In K 1
R0   In P0
a a

The price elasticity of the initial year is, therefore,

dR0 P0  1  P0 1
ε0     
dP0 R0  aP0  R0 aR0

Assume that  = –0.5; then we can estimate a:

1 1
a   0.1
εR0 0.5  21.7

We can also estimate the parameter K as follows:

K = P0 exp(aR0) = 20 exp(0.1  21.7)  175

The global oil reserve stock is S = 1150 billion barrels. The optimal oil extraction programme under

the assumptions of a discount rate  = 3% and perfect competition are given by the following.

1
The optimal exhaustion time is:

2Sa 2 1150  0.1

T*    87.5 years
ρ 0.03

The optimal initial oil output is

2ρS 2  0.031150
R0*  
a 0.1
 26.26 billion barrels

The corresponding optimal initial oil price is

P0 *  K exp( - aR0* )  175 exp(  0.1  26.26)

 $12.7/barrel

The optimal oil output is obviously higher than the actual output in 1990, and the optimal price is

lower than the actual one. So there is apparent evidence of distortion (inefficiency) in the world oil

market.