Question

Several Democratic Presidential candidates have promised to ban oil drilling on federal lands and

waters.

(1) Using supply-and-demand graphs, graph and explain what would happen to the price of oil if the US stops drilling on federal lands.

(2) Using what you know about oil production, explain why the immediate impact of a drilling ban would not be the same as long term impacts.

(3) The US produces about 12 million barrels of oil per day and consumes about 22 million barrels per day (mbpd). Global production and consumption are about 100 mbpd. About 0.75 mpbdcome from federal land, and about 1.75 mbpd come from federal waters (primarily the Gulf of Mexico). The current oil price is about $50, the elasticity of oil supply is 0.1 and the elasticity of oil demand is -0.2.

a. Using these numbers, calculate the long-term effect on prices and quantities of banning

drilling on federal land.

b. Using these numbers, calculate the long-term effect on prices and quantities of banning

drilling on federal land and federal waters.

(4) Should the U.S. ban drilling on federal lands, ban drilling on federal lands and federal waters, or maintain both areas open to drilling? Be sure to use your answer to question 3 in your answer.

Saudi oil facilities were attacked on Sept 15, taking approximately 5 million barrels per day of oil offline. Use the parameters from part 3 above and clearly explain any assumptions.

(5) How much would you expect the price of oil to go up? Hint: assume that supply and demand are linear and find the supply and demand curves that meet those parameters, then remove 5 mbpd.

(6) As of this writing, prices are actually up by about 8%. Is this more or less than your calculation? (Hint: the answer to 5 is not up 8%.) Give two possible reasons for the discrepancy.

Answer 1

(1) Using supply-and-demand graphs, graph and explain what would happen to the price of oil if the US stops drilling on federal lands.

This event will lead to supply shock of oil. Supply will shift to left. price levels will go up and quantity also goes down.

As shown in the figure below, supply shifts from s1 to s2, quantity goes down from Q1 to Q2 and prices go up from P1 to P2.New equilibrium is set at point B from initial of point A.

2. Long run impact would be different and will not be as severe as imports can bee made of oil to meet demand-supply mismatch. Alternative oil wells can be explored in the long run or electric vehicles can be produced on large scale with technology improvements. Hence substitutes and technology might change the severity of problem in the long run.