Natural Resource Economics Problem -
This problem revisits the question of oil reserve depletion but assumes per capita consumption is a function of the price of oil and previous levels of consumption. Assume world price of oil is initially $60 per barrel. Further assume that oil prices are fairly volatile. Specifically, let oil prices change randomly between -3% and +8% per year. This range ensures that the overall trend is positive, but allows prices to decrease as well. As oil prices increase, per capita demand should decrease.
The relationship between price and demand is called the price elasticity of demand, which is defined as: % change in demand/% change in price (or ΔQ/Q/ΔP/P). For most goods, an increase in price results in a decrease in demand. For example, if the price elasticity of demand is -1, then a 10% increase in price leads to a 10% drop in consumption. Oil demand is fairly inelastic, meaning that changes in price do not have immediate associated changes in demand. (In the short run, price elasticity of demand for gasoline is fairly close to 0, until prices exceed $4.00/gallon.)
Do this model at the world level (so not broken down into US and ROW).
Use the oil reserve numbers from the previous assignment.
a) Suppose the price elasticity of demand for oil is -0.25; what impact does this have on remaining reserves (in terms of how many years they will last)? What if the price elasticity of demand is -0.5? Please answer this question for both a starting reserve of 1654 and 2000 billion barrels.
b) Suppose that consumers are more price responsive as oil prices increase. Specifically, suppose that elasticities are -0.25 for prices below $100/bbl and -.0.5 for prices above $100. How does this change your answers from part a? (Adding this requires use of an "if statement.")
c) Now assume that for prices above $150/bbl, elasticity is -1.0. Comment on your findings.
d) Make use of the various "What-if?" tools in Excel to explore sensitivities. Comment on your findings.
e) Make one other modification to the model that you think makes it "more realistic." Explain your theory and your results. (Take this part of the PS seriously - impress me.)