Market Equilibrium Examples

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En provenance du cours de University of Colorado System

Fundamentals of Global Energy Business

310 notes

University of Colorado System

Fundamentals of Global Energy Business

310 notes

Learn about diverse and integrated markets for primary energy, and the essential considerations driving business leaders and policy makers in development of global energy resources.

À partir de la leçon

Energy Supplies and Market Allocations

A broad range of primary resources are used to satisfy our need for energy. Accessing these resources depends on many factors, including available technologies and skills, and a number of political factors. We will address these factors as well as issues and trends in energy supply.

Market Equilibrium6:33

Market Equilibrium Examples13:24

Energy Markets Summary4:48

Political Factors in Energy Markets12:23

Rencontrer les enseignants

Michael J. Orlando
Lecturer
Global Energy Management, Business School

Okay, so what we're thinking about here is how a market comes to equilibrium.

Now what we are going to observe when we take a look at a market place is we

are going to observe a price.

We might also observe a quantity, if we care, and care to dig far enough,

we'll see a quantity,

you can probably come up with an estimate of quantity of a good exchanged for.

But what we are typically interested in from as a particular business, rather

than a macroeconomist or someone, is the price that's popping out of the market.

Because the price is either going to, if you're selling into that market,

it's going to determine just how much you're going to make and what effort

the market justifies on from you, if you're demanding goods from that market,

it's going to kind of determine how costly things are.

So you know the quantity you need or you can deliver as a business.

What you're particularly interested in is understanding is how these prices

are evolving over time.

So here remember we're talking about our market for Henry Hubb natural gas.

This is a particular quality of

good quality gas in a particular location at the Henry Hubb in Louisiana.

And we're going to think about this as the front month contract let's say.

So a particular point in time, basically a month out.

What that information we have, which is the price and the quantity implies,

our model suggests that there are this abstract concept of supply curves and

demand curves floating around behind there.

And the price and the quantity that we observe is simply

the combination that at which the supply curve and

the demand curve of these abstract concepts intersect.

Now let's say that we have some new information that comes

into the marketplace, that we now anticipate a weak economy.

Maybe there's a report that came out and it turns out actually the economy or

the labor market is a lot worse than we thought, we didn't realize it was this

weak, how is this market going to react to that new piece of information?

Well, the first thing you want to do is

go back to these determinants of supply and demand.

If we think about the determinants of supply, for

the most part it's technology and costs.

Now there's really the the new

information that the economy is actually weaker than we thought.

It doesn't really affect our technology.

We still have available the same technology for addressing

the same problem of getting gas out of the ground, let's say in this example.

So that hasn't changed.

And our costs, for the most part, haven't changed.

There may be some feedback effects if the economy really starts to tank,

that there will be less demand in other markets, but

the first round effect here of a weak economy is not going to be an impact

specific to the cost structure within this market for natural gas.

So what that means is that our supply curve,

under the new information is the same as the supply

curve was before under the old information.

Now let's think about the demand curve.

So, we could probably rule out change in the relative valuation of goods,

natural gas versus other goods, probably the relative value hasn't changed.

The really primary effect has been an impact,

what we anticipate to be an impact on income.

Incomes are going to fall, because the economy is weaker.

Now, you could make an argument that there is going to be some impact

on the relative value of goods, because maybe natural gas is more of a necessity.

And so, you'll really see the income effect resulting in

a pull back in demand for other types of

let's say luxury goods or discretionary goods.

Maybe the relative value of gas actually will

increase with the retrenchment in the economy.

This just means that the impact of this second factor Is probably

going to mitigate some of the primary impact, but the primary impact here really

is that everyone is now anticipating being less wealthy than they were before.

And so the result of that is a shift back in the demand curve, okay?

So the old demand curve,

when this information starts to work its way into the market,

the first effect is this shift back in demand.

So under the old price, suppliers are still producing something here,

but consumers now are gonna desire at that old price,

much lower quantity of gas.

And so what's gonna happen is producers are going to bid down

the price to get rid of their excess inventories until this market

eventually clears at the new lower price and lower quantity.

So let's think about a different change here.

So we have our same market for natural gas at the Henry hub.

In this case, the new information is a cold snap.

So it's also a weather event, but it's a different weather event.

Cold expected in the northeast,

a significant natural gas consuming region of the country.

So let's think through how this is going to effect our market for natural gas.

Again, in the case of the supply curve, this for the most part,

we wouldn't think is going to affect either our technological capabilities or

the costs of production.

We do nowadays have a significant amount of production in the Marcellus,

in the northeast, but unless it were you sort of record breaking cold weather,

you wouldn't think interfere with the production activity for the most part.

So this is really primarily going to leave the supply curve

where it was, the real impact is going to be the demand,

and it's not because this cold snap is going to affect incomes in anyway, but

it's going to affect the relative valuation of goods by consumers.

Consumers are going to decide maybe under this cold weather that they

really value the ability to keep their house relatively warm and

comfortable, so they might forego other goods and

shift consumption, shift expenditure into this market.

So the relative valuation of natural gas is going to increase,

that's going to shift out the demand curve.

So with this new information, we now have much higher demand.

Of course, at the initial impact of this shift in demand

at the original price is that demand is going to exceed supply.

And so we're going to see consumers who are going without,

because as gas is relatively scarce, bid up the price of gas.

And producers are going to respond by opening the taps a little bit more,

until we have a new market clearing price and quantity.

So with the shift out in demand,

we have a higher price and a higher quantity.

With a shift in demand, we're moving along the supply curve to have a lower price and

a lower quantity.

Let's consider another situation.

Here we have again, our market for

Henry Hub Natural gas front month contract.

Here the new information is a weather event, but

in this case it's a hurricane in the Gulf of Mexico.

So a different type of weather event.

What exactly does this mean for our guest market?

Well, for

the most part this is going to certainly effect, this weather

event may effect some people in the Gulf if it gets close enough to shore.

But you know we can for the sake of argument, assume that this hurricane is

something that's going to get too close to land, so it's really not going to effect

the major consuming, the major population centers around the country.

It's not going to effect therefore incomes and it's not going to effect so

much the relative value of goods.

So we can think of the demand curve essentially staying put.

Here, the real impact is on supply.

So there may be a couple of ways you can think about this weather event.

You know, one would be that it's kind of a negative technology shock.

It sort of makes the existing technology

basically becomes less appropriate or effective for the prevailing conditions.

Another way to think about it is it just increases the costs of production and

the complications associated with this weather.

We know, in practice, what it really means is these, for safety reasons,

these facilities largely will need to shut in.

And so that is going to take a bunch of supply off of the marketplace.

Okay, at the old prevailing price,

consumers would still desire a relatively

large amount now as compared to the quantity

supplied under this new weather conditions.

And so consumers are going to bid up price to the new market clearing price,

which is now higher than the old price was, even though demand is

much lower than the quantity that was exchanged prior to this weather event.

And lastly, let's consider a situation

where we'll see an increase in supply.

So in this case,

the new information is an innovation that we just discovered.

It's horizontal drilling and hydraulic fracturing.

What exactly was the impact of this on the marketplace for natural gas?

Well, maybe if you were fortunate enough to be the one to participate in this

innovation and capitalize on it, it may have effected your income, but for

the most part, this was kind of a sector specific innovation.

It really was the new opportunities and wealth created by that,

were kind of isolated to a particular sector.

Certainly those wealth effects are going to ripple through the economy, but for

the most part, overall income and

the relative values of goods were kind of unchanged in the minds of consumers.

So the demand curve didn't really, we'll think about that as not really moving.

Okay, but the supply curve is what moved, and improvement in technology,

you can either think of that as under prevailing conditions, we can just

produce more with the same amount of thinking in capital and other stuff.

Another way to think about this technological improvement is maybe you

could think of it as just reduce the cost of resource development.

Either way, those things result in a shift out in the supply curve.

And so with this new supply curve at the old price,

consumers were demanding that old quantity.

But, producers are now, with this new supply group,

willing to deliver a lot more.

And because there's a surplus, Maybe producers

start cutting the price they want to get for this just to get it off their hands.

Prices drop down, and we eventually come to

a new price that equates demand with supply on the new supply curve.

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