Sample Paper on Economic Problem of Scarcity of Oil

 Economic problem of scarcity of oil


Oil is an exhaustible resource that is behind world industrialization and development hence considered as the global principal source of energy (Cassedy & Grossman, 1998). There is rapidly growing demand for this resource due to high rate of global industrialization, highly growing population, and ultra-modern technologies that aid discovery of new oil reserves. People use oil to heat their homes and drive their cars, and industries use it for manufacturing and production activities. Between the years 1980-2008, it is estimated that global demand increased by about 40%; from 60 million barrels a day to over 80 million barrels per day (International Energy Agency, 2007). The increased demand brands this commodity as scarce, and this is enough reason to worry as oil reserves may get depleted and lead to global turmoil (IMF, n.d.). This report has detailed the global demand and supply of oil, and reasons for the fluctuating prices.

Demand and supply of oil

Like any other economic commodity, oil is subject to demand and supply laws. Oil demand is the quantity that consumers are willing and able to purchase at a particular time whereas supply is the quantity that oil suppliers are willing and able to sell at certain or given prices, other factors held constant. The demand laws state that the higher the price, the lower the demand i.e. consumers will not be willing to dig deeper into their pockets to purchase oil when prices go up. Supply law, on the other hand, states that the higher the price, the more the oil supplied to the market i.e. suppliers will try to sell more at high prices to earn more revenues (Bodenstein, Erceg & Guerrieri, 2011).

Basically, the demand for oil is inelastic in the short-term in regard to price levels. This means that high price increases do not affect to a high degree the quantity in demand. Here, people or industries cannot shift to using a different source of energy i.e. if one used petrol, they will have to bear the price increases and continue using the petrol within the short run as they think of alternatives in the long run (“Joy of Economics,” n.d.). Supply is purely elastic with price levels in the short run as producers engage in high production to take advantage of the high prices.

Current oil price fluctuations

For many years, oil prices had risen to abnormal levels (Cavalcanti, Mohaddes, Raissi & International Monetary Fund, 2012). The big winners of the high pricing were the oil cartels such as Organization of Petroleum Exporting Countries (OPEC) and other oil producing giants like Russia (Kilian & Centre for Economic Policy Research (Great Britain), 2006). However, there has been a turnaround in the recent years as oil prices fall substantially all over the globe. In June 2014, barrel price in the United States was about $115 but by January 2015 it had experienced a free fall to about $49 a barrel. Simply, the price has fallen by almost half in the past year. This has led to massive losses in energy exporting countries such as Russia that are about to face an economic meltdown, although, other countries like the U.S have gained due to commencement of staggering oil production (“Falling oil prices: Who are the winners and losers? – BBC News,” n.d.). The fluctuating price levels have been majorly associated with demand and supply forces (Bodenstein, Erceg & Guerrieri, 2011).

Demand and supply factors behind the falling oil prices

Issues with production and price adjustments in major oil producers

The OPEC countries forming the largest oil supplying cartel faced problems in adjusting production to match demand. Since prices had fallen so low, these producers ought to have cut down their production so as to push the prices back to normal. However, some countries such as Saudi Arabia failed to do so for fear of their balance of payments. Reluctance to cut down production levels was the major reason why prices kept going down (Lehr Wagner & Heather, 2008).

Improved technologies to extract oil in the United States

The global demand for oil has always been high causing developed nations to seek means to drill oil from areas that are known to be difficult for extraction. United States is a good example of a country that has commenced heavy drilling with advanced technology. The country has established oil drilling plants in states of North Dakota and Texas. The exercise is fruitful as it is estimated that U.S has been supplying about 4 Million barrels per day to the world oil market. Other countries like Canada have followed suit as they have commenced exercises to extract crude oil.

Therefore, with commencement of oil drilling in North America, there has been overproduction that has relatively exceeded demand. The high production has resulted to price falling substantially. In the U.S, gasoline and other oil products have become so cheap due to the country’s involvement in oil production. The oil boom in the North America, therefore, caused global oil prices to significantly fall although its effect lasted for a while until other factors such as geopolitical differences coming in.

Weak economic activities and increased efficiency

Energy demand all over the world is related to economic activities of countries that are the energy consumers. These activities encompass manufacturing and production, and general industrialization. When industrial activities that are meant to boost the economy, there is a possibility of decreased demand for oil and its products. This is one of the reasons for falling oil prices as most countries especially in the third world are now engaging in weak economic activities that stagnates the economy and consequently demand for oil. There is also increased efficiency especially in the oil producing companies as catalyzed by advancing technology hence more production that exceeds current demand. This contributes to falling prices, as well.

Growing switch to other energy sources (oil substitutes)

It is unquestionable that the current world virtually depends on oil as the energy source. However, oil is basically expensive in developing economies. This has led to most countries seeking alternatives to run their industries. Solar energy, for instance, can be tapped from the sun and be stored in gigantic batteries and provide the required energy. This plus other sources can easily substitute or aid limited requirements for oil. Countries that have embraced alternative sources of fuel besides of oil have led to decreased demand that consequently lowers the prices of oil.

Demand downturn by the world’s great energy users

Initially, the global demand for oil had gone so high due to major energy consumers such as China. This is because of the big economies they run characterized by big industries that require a lot of oil (Cashin & International Monetary Fund, 2012). However, there has been a downturn by such countries that needed more oil by reducing their energy requirements due to global recession. This is a major factor that has led to decreased prices of oil as there is basically overproduction that exceeds demand. Fall in global demand can be illustrated below;

Fig. Fall in global oil demand (“market for oil,” n.d.)

As it can be observed from the graph, the fall in demand from D to D1, causes oil prices to go down from $100 to $40. Rise from D to D2 increases prices from $100 to $125.


2.      Externalities and government solutions

Externalities that may arise from consumption of oil

Oil is basically a useful resource but it comes at a societal cost besides the gains. Externalities are social impacts on parties that are not involved in oil production and supply and can be either gains or negative impacts. It is the responsibility of stakeholders especially the government to seek remedial actions to either encourage gains or discourage negative externalities. This report details various externalities and possible government responses.

Negative externalities

Global warming

Global warming is the gradual increase of earth’s atmospheric temperatures. One may cause of the rising temperature is gas emissions from the earth from industrial, human and natural activities. Oil comes in as the major cause of global warming since its consumption in the industrial sector and in households leads to gas emissions to the atmosphere. Industries run their machines using oil products to emit gases such as carbon IV oxide, and this is the same case to vehicles that release the same gas with combustion of engines. The carbon gas and other green gases cause greenhouse effect i.e. trapping solar radiations. The gases deplete the ozone layer that filtrates ultraviolet rays from the sun, allow the radiations to the atmosphere and absorb their heat as they are radiated back from the earth (Gore & Melcher Media, 2006).

The overall impact of global warming on climate is considerable. It leads to shifting of major climatic zones and patterns hence affecting human activities in most parts of the world (Gore & Melcher Media, 2006). Consequently it leads to catastrophes such as floods, droughts, and ice melting. Floods makes people run away from their homes and floods render places unproductive. Therefore, oil has an indirect negative impact on the climate and consequently on people.


Oil is one of the major pollutants on the environment today. Leakages and spills leave the environment in a harmful and undesirable state. Usually, leakages and spills are swept with rain water hence finding way to rivers and other water bodies. Oil affects aquatic life as it may lead to contamination and reduction of oxygen content in the water leading to death of aquatic life. The 2010 oil spillage in the Mexican gulf connected to the BP (British Petroleum) company is one bigtime example of how oil impacts the environment negatively. A BP pipe had leaked deep in the ocean floor about 40 miles from the coat of state of Louisiana. More than 3 million barrels was lost to the sea and this affected aquatic life heavily. The oil spill that was branded as the worst in history illustrates the pollution externality associated with oil (“Oil Spill Gulf of Mexico 2010 | Smithsonian Ocean Portal,” n.d.).

Air pollution is also a negative externality with oil consumption. Vehicles and manufacturing industries emit gases to the atmosphere leading to various adverse effects. Besides the already discussed global warming, these gases cause acidic rain that consequently cause damage to property such as iron substances due to corrosion. Either, polluted air with harmful gases have other health hazards whereby the gases may lead to breathing system diseases. Still, oil affects the soil due to spillages as it loses fertility that support plant life.

Creation of ugly natural views and destruction of natural habitats

Oil drilling involves heavy extraction that renders the surrounding environment to have an ugly view and scenery. Normally, it is difficult to live in those places after mining has taken place as the shapes do not allow for other constructions. Oil drilling, therefore, leads to creation of derelict land.  Either, it destroys places that shelter various wild animals rendering them homeless.

Political strives and civil wars

Oil is an attractive resource hence it attracts civil strives and wars as people or nations fight for this resource. It is common to hear war in oil mining giants like in the Middle East, Russia and Nigeria. This affect the lives of people as they are caught in between the hostilities and often civilians lose their lives.

Positive externalities

Usually oil is associated with negative impacts on the society but it has positive externalities, as well. It is a fact that it has enhanced technological development. Basically it has enhanced technology growth as countries use it to explore for oil and also extract it in areas deemed difficult to extract. Oil consumption has also improved economies of producing countries that in turn renders more employment opportunities and a higher standards of living. For instance, North Dakota and Texas oil drilling areas have attracted populations that have led to urbanization of the areas. Consequently the urbanization process has enhanced business opportunities that have created various employment to the people (North Dakota & North Dakota, 2006).

Government solutions to externalities from consumption of oil

The government is mandated to look after social welfare and justice. Therefore, it ought to come up with solutions regarding positive or negative externalities. Positive externalities are for the good of the society hence the government should boost and encourage them. However, negative externalities require measures to curb or prevent them or mitigate their effects. This report has recommended the following remedies regarding negative externalities that come as a result of oil consumption;
Tax incentives

The government can use tax incentives to regulate externalities such as pollution from oil. This can be through increasing taxes on industries that emit harmful gases or oil-contaminated effluents. This can help reduce such pollution or help in cleaning the mess created by these industries.

Setting environmental regulation and monitoring agencies

Pollution is the main externality associated with oil usage. The government should come up with agencies or authoritative bodies that give guidelines and solutions regarding pipe leakages and spillages that end up in rivers and cause pollution. For instance, vehicles that highly emit exhaust gases can be banned from roads.

Rehabilitation of derelict land

Land that has been rendered useless after oil extraction can be reclaimed or rehabilitated. This can through planting of cover such as trees so that they can regain back their utility. Governments can, therefore, direct the extraction companies to ensure that they don’t leave the sites bare but ensure they are put into other uses towards environmental conservation.

Seeking alternative sources of energy

Oil may be the primary energy source but not the sole source of energy. There are plenty of energy sources including solar and wind (Nersesian, 2007). Most of these sources are not associated with externalities brought about by oil hence they can be substituted to reduce negative impact on the environment.


Retrieved from

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Cassedy, E. S., & Grossman, P. Z., 1998. Introduction to energy: Resources, technology, and society. Cambridge, UK: Cambridge University Press.

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