Sample Economic Analysis (Hypothetical Scenario): "Oil at $100 per Barrel"

Research PaperEconomics
Jul 1, 2009


The current price rise of crude oil to $100 per barrel and it forecasts the price of the oil using key determinants. The article discusses the law of supply and states the existing scenario of oil prices is an exception to the case. Then the article explains the transition of oil prices from buyers market to sellers market. Then the basis of pricing in each market is discussed. The demand-supply gap is then discussed. In a sellers market, pricing of oil is done through three main aspects viz- Value of equivalent human energy, Sustainable energy creation costs, Affordability of the least rich marginal consumer. The discussion then shifts to the US perspective where the oil price is determined to a great extent by the Americans. Nearly 25% of the world's oil supplies are consumed by the USA. The article concludes by stating that the price of crude oil may go up to $200 per barrel in the coming years.

Primary Economic Elements

The demand in the output markets is determined by the households from the above diagram. A household’s decision about what quantity of a particular product depends upon the following factors and all the factors are getting affected due to the price hike.

  1. Price. The price of the product is the major issue. The price of 1 barrel of oil is raised to $100.
  2. Household Income . A household’s income is the sum of all the wages, salaries, profits, interest payments, rents, and other forms of earnings received by the household in a given period of time. The price rise is going to increase the expenses and less the savings.
  3. Household Wealth . Wealth is the total value of what a household owns less what it owes. It is the amount left after a household sells off all its possessions and pays off all its debts.
  4. Competitors.  Other products include substitutes (Solar power, Electric Battery, wind power, etc.) and complementary goods (Cars and Automobiles, etc.). Due to this price rise, the prices of these substitutes and complementary goods will remain affected. Substitutes, a favorable condition exists and for complementary goods, the condition worsens.
  5. Dynamic Demand. The households’ tastes and preferences will change.
  6. Changes.  The household’s expectations about future income, wealth, and prices also will change.

Ultimately, the law of demand  – “As price rises, quantity demanded decreases and vice versa” will play a crucial role in households' decision-making.

Impact on Airline Costs and Pricing

The Oil prices hitting about $100 per barrel makes a huge alarm in the airline market. Nowadays airline owners are slowly switching over to use natural gas. A discussion of the economies. Economies of scale include the factors of production like

  • Indivisible Fixed Costs. The cost of inputs cannot be scaled down below a minimum level in the case of car production. Airline manufacturing is a highly capital-intensive one.
  • Specialization. An airline production line has various specialized departments like shaping, molding, assembling, etc.
  • Purchasing. Large orders may cost less because suppliers accept lower prices to secure steady demand, customers exploit market power
  • Research and Development. The major focus is on technological improvement in the airline market.

Competitors' Reaction

The competitors include the trains and buses. The reaction from the side of trains is the introduction of luxurious coaches and a drastic reduction in the travel fare. The same price cut can be seen in the case of buses also. Nowadays buses also provide sleeping coaches. For all the reactions, Airline has only the time advantage.

Factors Driving Demand

  1. Income. Income is an important factor to be considered regarding air travel. The higher the income, the better it is for the airline market. Air travel is a luxurious product and nowadays low budget airlines are becoming more popular. This is going to create a separate customer market between train commuters and Business class travel. Since Air travel is now available at a lower cost all the factors change. This will create a movement of the whole curve (a change in the level of demand).
  2. Distribution of Income and Population.  This factor is a crucial one for the marketer to position the market and segment it. Demand for any product will almost certainly depend upon the distribution of the population and income across age groups, classes, and regions.  In the case of Airlines, London is considered to be a high-income area. Marketers must now target this area to sell high-quality high-priced Airlines. Similarly, marketers must target different areas according to the income level for different budget Airlines.
  3. The Price of Substitutes.  This is again another important factor. The substitutes have a great impact on the sales of Airlines. Once there is a threat of terrorist attack in the trains, then the sales of Airlines would pick up as it happened recently in London rail bombings. Similarly a price or fare cut in buses and trains can have a drastic negative impact on the airline market.
  4. The Price of Complements.  This factor is a serious issue as the complement product of Airlines is petrol or gas. Recently, the price of a barrel of oil has hit $100. This indicates that the maintenance cost of Airlines is going to raise and also the running cost. The variable cost will be an issue to watch out for while purchasing Airlines and this may lead to a fall in airline sales drastically.

Technology and Airlines 

Technological progress forces the average cost curve to fall.   Such progress includes human capital i.e. the skills and knowledge contained in people.  Technological progress has been the principal engine of economic progress. In Airlines, technology plays a major role in contributing to the economy as a whole. HCL is a major player in developing software for the airline market. They have Airbus and Boeing as their major clients.


The sellers market will have a drastic impact all over the world. The Demand-supply gap in a buyers market is that demand will be lower than the supply for most parts. In a sellers market, demand will be higher than supply and recessions would indeed cause demand to fall. This is the real scenario that now exists in the U.S.A. The rule of thumb is when the demand tries to go beyond the supply line, there will be shortages. The future looks gloomier where the price of the oil may even go up to $300 per barrel. The substitute products must take full effect then.

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