"Money Ain't a Thing"

In the Ferrari or Jaguar, switchin four lanes
With the top down screamin out, money ain't a thang
Bubble hard in the double R flashin the rings
With the window cracked, holler back, money ain't a thang
Jigga, I don't like it if it don't gleam gleam
And to hell with the price cause the money ain't a thang
Put it down hard for my dogs that's locked in the bang
when you hit the bricks, new whips, money ain't a thing

Supply, Demand, and the Economics of War

Repeating from Monday: For Homework 4, you DO NOT NEED TO DO THE PROBLEMS FOR CHAPTER 8.

Given the snow day we lost, I will not be able to cover all of important points in Chapter 7. Therefore, I will hold you responsible for the material in this chapter only through the first paragraph and figure on the top of p. 175.

Exam review for Michele Mattingly's students:

Tuesday, March 11, 6:30 p.m., in 126 Hasbrouck

Where we left off in Chapter 6:

Under perfect competition, the individual firm faces a horizontal demand curve. It cannot affect price. If we take its costs as a given, all it can do is choose the profit maximizing level of production. This is the point where the marginal cost equals the marginal revenue (which, in this instance, is the same as the price).

Numerical example:

Fill in the missing column for profit per unit and you will see that the profit maximizing point is where Q=6, which is where MR=MC (marginal cost)

Chapter 7.

Key concept is "surplus"--

consumers' surplus is the difference between what people were willing to pay and the price they actually pay

producers' surplus is the difference between what they were willing to sell their product for and the price they actually get

add consumers' surplus and producers' surplus and you get total surplus.

If you draw a straight line representing the equilibrium price on the vertical axis, the triangle between that line and the demand curve is the consumer's surplus; the triangle between that line and the supply curve is the producer's surplus.

If you interfere with the workings of supply and demand through government regulation, such as setting a minimum price for something that is below the equilibrium price , you not only reduce the quantity supplied and create excess demand; you also reduce the size of the surplus. In this case, draw a vertical line at the quantity supplied. The area to the left of that vertical line represents the surplus actually enjoyed. The triangle to the right of that line between the supply and demand curves represents the surplus that is lost.

This is an other demonstration of the cost of interfering with the working of supply and demand in the competitive market.

Hints for Ch. 7 homework assignments.

You do not need to calculate the actual amount of the surplus, just indicate it graphically.

You have equations for a demand curve and a supply curve and are asked to sketch them.

e.g. P= 12 - .25Q.

these are equations for a straight line. if you know 2 points on a straight line you can graph them. Set Q equal to 0 and solve for P. On a graph, the point where Q is equal to zero is the point on the P axis, or the P intercept. In this case, 12. Next, set P equal to 0 and solve for Q. Subtract 12 from both sides of the equation and multiply by negative 1

12 = .25Q 
Q=12/.25=48

Now you have two dots and if you connect them, you have the demand curve..

What is the equilibrium price? You can probably figure this out graphically. Or you can set supply equal to demand:

12-.25Q=6+.75Q

solve for Q

once you know Q you can substitute it in either equation to determine the equilibrium P.

The Economics of War

Prelude:

Imagine that you are on a plane. You have purchased a ticket to Florida for spring break. The pilot announces that there has been a change of plans. He is not flying to Florida. He has decided to bomb Iraq. He says the dictator of that country is a dangerous despicable liar and should be forced to step down. You ring the stewardess button. "Look," you tell the stewardess, "I agree that Saddam Hussein is a dangerous despicable liar, but that doesn't mean we should bomb his country. One half of the population of Iraq is under the age of 14." The stewardess has a dazzling smile. "The pilot knows best. Tea or coffee? Or would you like some juice?

You get on your cell phone and talk to people all over the world. Millions of people demonstrate in the streets. These are the biggest anti-war demonstrations in history against a war that has not yet started. The pilot laughs. "I am the leader," he says. "Don't worry. We will win. We will make everything better."

All you can think about are those passengers on a hijacked plane who decided to crash and burn into the Pennsylvania earth rather than serve as agents of destruction. But you can't do what they did, because it this case, the pilot is a Commander in Chief, wearing an official uniform and many of the the other passengers are perfectly willing to follow his orders. All you can do is take out a big felt tip pen and write on the plastic wall of the airplane the following message:

"A war of aggression is an act of terrorism."

The stewardess immediately shows up with a paper towel saturated with Mr. Clean and wipes the message off. But as soon as she leaves, you write the message again and again and again.

The Supply and Demand for Oil

Business Week article on-line from the week of February 10, 2003.

It's Not "All About Oil," but...Victory in Iraq would reshuffle the global players with big stakes in the country's oil fields. When tens of thousands of protesters opposed to a U.S. war in Iraq descended on Washington on Jan. 18, you could see the placards everywhere: "No U.S. Blood for Oil." Convinced that a war would be nothing more than a thinly veiled resource grab instigated by Big Oil, activists vow to follow up on Feb. 4 by staging protests at gas stations across the country. Fringe thinking? Hardly. The suspicion that George W. Bush's showdown with Saddam Hussein is "all about oil" isn't just a fixation of the American Left. It's gaining adherents among the European intelligentsia and in the Arab world.

"Washington says it wants to eliminate any threat of interruption of the flow of oil, to ensure that it will be accessible to U.S. oil companies," said British Labor Party politician Alice Mahon on Jan. 22. "A different and more compliant government in Iraq would make that possible."

Naturally, the Bush Administration and U.S. oil companies bristle at that charge. In his Jan. 28 State of the Union address, the President called Saddam "a brutal dictator" and insisted that the Iraqi leader and his weapons of mass destruction "will not be permitted to dominate a vital region and threaten the U.S." Adds an American oil industry source: "I would be shocked if any industry executive is wringing his hands in glee" over the impending conflict. In the short term, many oil companies and producers could in fact be hurt by a U.S. victory. If the U.S. gets more oil from Iraq, that would drive the price down, says the industry exec.

Still, when Bush says "vital region," he's alluding to the obvious: While the war with Saddam is not driven by a U.S. lust for Iraq's oil fields--second only to Saudi Arabia's in terms of proven reserves--he is not about to let a vicious strongman with ambitions to be another Nasser-style, pan-Arab nationalist control the crucial area either.

What's more, when U.S. oil execs profess dismay over the drop in world crude-oil prices that could follow American seizure of Iraqi fields, they're only telling part of the story. In the long term, assuring a larger and more stable supply outside of Saudi Arabian domination could benefit both the U.S. and world economy. And modernizing the decrepit Iraqi oil industry will be a huge opportunity. Just making Iraqi facilities capable of pumping oil at 1990 levels could cost $5 billion, says a study by the Council on Foreign Relations and James A. Baker III Institute for Public Policy. Doubling capacity from the current 2.8 million barrels a day might cost $40 billion.

Since the U.S. military would control Iraq's oil and gas deposits for some time, U.S. companies could be in line for a lucrative slice of that business. They may snag some drilling rights, too. "The oil-service industry is pretty much American-dominated," says an exec at one U.S. company. That means outfits such as Halliburton Co. (HAL ) and Baker Hughes Inc. (BHI ), as well as construction giant Bechtel Group Inc., could feel just as victorious as the U.S. Special Forces troops.

The mere prospect of a U.S. presence in the region troubles the French and Russians--both key to the U.N. drive to head off war. The French have long been a major player in developing Iraqi fields. And the Russians, via companies such as Lukoil (LUKOY ), are angling for a piece of the action. They, too, are worried about anything that causes crude-oil prices to fall. The war "is totally about oil," says a top executive at France's TotalFinaElf (TOT ). Adds Simon G. Kukes, chief executive of Russia's Tyumen Oil Co.: "I don't see much room for Russian oil companies" in postwar Iraq.

The anxiety is high because Iraq's oil treasure is vast. Only 15 of its 74 discovered oil fields have been developed, and just 125 of the 526 known oil deposits have been drilled, according to CFR-Baker. Currently, Iraq is only bringing in $16 billion annually from oil sales--paltry by OPEC standards. And its deteriorating infrastructure means that output is dropping by about 100,000 barrels over each successive year.

But that picture could change dramatically if the U.S. military staves off Iraqi sabotage and puts in place a new regime committed to hurry-up modernization. If Iraq opens its oil taps, that would be a powerful psychological force for lower oil prices worldwide. "The whole market will flip from bullish to bearish," says Fareed Mohamedi, chief economist at PFC Energy in Washington.

What about tapping some of that oil to pay for the war? According to Secretary of State Colin L. Powell, the U.S. won't fund its military campaign from Iraqi oil revenues, but reserves the right to use some of Iraq's black gold for reconstruction. "The oil of Iraq belongs to the Iraqi people," Powell said on Jan. 21. "It will not be exploited."

So who will reap the big bucks from getting Saddam's oil fields back on track? At this point, Iraq is believed to have contracts worth about $38 billion pending with such companies as Italy's ENI (E ), Royal Dutch/Shell (RD ), Australia's BHP (BHP), TotalFinaElf, and Russian giant Lukoil. Sanctions have precluded American companies from doing business in Iraq, and foreign concerns are likely to continue to exploit their long-standing links. Yet the sanctions have also stalled efforts by non-U.S. companies to complete their deals and start development.

France is by far the biggest player. The giant TotalFinaElf now has development rights to roughly 25% of total Iraqi reserves. In theory, France's long relationship with Iraq's nationalistic oil technocrats could put French outfits in good shape for more deals after any war. But at the moment, many French industry officials remain convinced that the Americans will exact revenge if France fails to fully support the war effort. While Russian contracts may be honored, "ours won't be," predicts a top executive of TotalFinaElf. That's why some French observers insist that when push comes to shove in the U.N., France will march in step--mainly to protect its oil stakes.

Russia is in a more delicate position. Iraq owes Moscow $8 billion in Soviet-era debt. In 1997, Lukoil signed a $3.5 billion, 23-year deal to revive Iraq's al-Qurnah field, which has 7.8 billion barrels of proven reserves. But the accord was put on ice after President Vladimir V. Putin's support for the U.S.-led sanctions drive. Now Lukoil is sending a high-level delegation in February to heal the breach--the second such diplomatic overture in recent weeks.

Lukoil President Vagit Alekperov claims to have Kremlin assurances that his interests will be protected in a post-Saddam regime. That has many industry observers convinced that an informal accord with Washington is in place, one that would restore Lukoil's stake in Iraq.

For American energy companies, smarting from the charge that former oil execs George W. Bush and Vice-President Dick Cheney are spearheading their interests, the subject of economic gain from an Iraqi intervention is extremely sensitive. U.S. oil executives queried by Business Week would not speak on the record. Privately, industry sources familiar with discussions with the Administration say the talks focused on nitty-gritty issues such as snuffing out oil fires Saddam's forces may set. And the industry remains torn on what impact war in Iraq will have on its fortunes. In the short term, Iraqi infrastructure rebuilding projects might be sweet deals. Yet over the long haul, a flood of Iraqi oil could depress world prices. Bottom line in the Oil Patch: Keep your lip zipped, hope George W. is right, and go along for the ride.

By Stan Crock, John Carey, and Laura Cohn in Washington, Paul Starobin in Moscow, Wendy Zellner in Dallas, and bureau reports.

********************************************

Let's look at the oil industry in terms of supply and demand curves.

The demand curve for oil is relatively inelastic, especially in the short run. We depend on gas and heating oil to meet basic needs. We import a large percentage of our oil from the Middle East.

The oil industry is not competitive. Much of the supply of oil from other countries is controlled by OPEC, the Organization of Petroleum Exporting Companies. They restrict the quantity of oil supplied to keep prices high. But they don't try to set them too high, because they realize that this could discourage demand in the long run--consumers would move more rapidly toward fuel efficient cars and energy conservation.

Recently oil prices have gone up, because of political instability in Venezuela, and also because of the threat of war. As the U.S. invades Iraq it will seek to secure Iraqi oil and guarantee a long run supply of relatively cheap oil for the U.S. The Iraqis will probably try to destroy and disrupt oil production.

What about the demand side? Advocates of energy conservation argue that if we took more aggressive action now to encourage greater fuel efficiency, we could lower the price of oil AND reduce our dependence on foreign sources of oil by shifting demand to the left.

An example would be setting high fuel standards for cars--or simply requiring that SUVs, like other automobiles, be required to meet minimum fuel efficiency standards.