The factors of production refer to the inputs used in the production of goods and services when a business is trying to achieve viability through economic profit. There are two categories of factors of production which include tangible and nontangible resources. The former comprises of land, capital, and natural resources; while the latter consists of knowledge, entrepreneurship, and labor. Consequently, in the factors of production, the quantities and prices are determined by demand and supply. There is empirical evidence of these factors affecting various markets, with one of the current events that aid in exemplifying this theory being the decision made by Saudi Arabia to shift the supply of oil market upward in the fourth quarter. Through reviewing the decisions undertaken to come up with the decision, the paper will present policy decisions affiliated with “factors of production” affecting the ever-shifting oil market, while also examining the implications it has on the market.
Before examining the Saudi’s case, it is essential that a firm grip of how the factors of productions operate. Firms weigh the cost needed to produce one unit of an element in output against productivity; additionally, they expand the usage of the component to its maximum profitability. The supply and demand of the market for the product that the firm deals with drives the factor market. It is these balances that are determined by the market, customers, factors of production, among other things, that determine the price of a product in the market; arguably, this affects even subtle upward or downward trend experienced in the global pricing of the same.
The review of the article “Saudi Arabia Says Oil Market Could Shift to Oversupply in Fourth Quarter” by the New York Times shows how the oil companies in the gulf apply microeconomics principles to fix pricing, through controlling demand and supply amongst their member nations. According to the Saudi Arabian OPEC governor Adeeb Al-Aama statement, the country’s economic tacticians have been viewing the trend of oil supply shifting upward, which is evidenced over the past weeks by a rise in inventories (Gamal & Ghaddar, 2018). Arguably, this means that there was an oil surplus in the market, which was caused by low demand; this could lead to a shift in the supply and demand equilibrium making the prices to dip.
Adeeb Al-Alma continued by saying that OPEC was watching the market to ensure that their actions did not result in over-correction which would result in significant inventory build (Gamal & Ghaddar, 2018). This statement seems to echo recent development experienced by the OPEC and non-OPEC members, whereby they suffered economic uncertainties due to rising inventories; arguably, this occurred due to their agreement earlier in June to relax on the oil cuts. Inventory build-up refers to the production of excess units than those needed for immediate sale (Chowdhary, 2009). These surplus units increase the supply, which results in fluctuations in price.
Figure 1 shows what happens when supply and demand for a product reach equilibrium. At this point, the demand for the oil and its sale is at its prime without any surplus produced, or deficiency experienced; this results in a price which the customer is willing to pay for a certain quantity of oil supply (Lai & Yu, 2006). In figure 2, a scenario shows as the excess supply, and S as the supply; the excess products produced results in the producers trying to sell for higher prices resulting in less demand and consequently, the prices for the commodity lowers (Lai & Yu, 2006).
Supply and demand Equilibrium Point in the factors of production
Figure 1: Supply and demand Equilibrium Point
Supply and Demand for Surplus Oil in the factors of production
Figure 2: Supply and Demand for Surplus Oil
Saudi Arabia is a member of the OPEC, which was founded in 1960 by the world’s major oil producers; consequently, its main aim is controlling and setting its price. It can, therefore, be seen that for Saudi Arabia to adhere to OPEC’s goals, and also for maximization of its benefits, it must maintain the costs at the most optimum point. It is, therefore, surmisable that the relaxation on oil cut resulted in the OPEC and non-OPEC countries overproducing oil, and when the demand fell, it resulted in rising inventories; consequently, this led to the oil prices falling in the global market.
When asked whether OPEC had concerns about slowing the economic growth of countries that were heavy consumers like China, the Saudi Arabian OPEC governor replied that oil demand responded to factors tied to global macroeconomics, and promised that the organization would react to the changes with their partners proactively. These fears are unfounded on the part of China, according to a paper by Du, He, and Wei (2010), the country’s GDP positively correlates to the world’s oil price, with no relationship found between rising oil prices and reduced GDP.
Adeeb Al-Aama also notes that OPEC understands that growth risks are a huge concern especially in emerging countries, and they will do all they can to make sure the risks get mutually shared. Adeeb Al-Aama also added that Saudi Arabia majors on responding to the customer’s demands rather than needlessly push the oil to the market (Gamal & Ghaddar, 2018). He noted that the rise in demand spurred the increase experienced in oil production over the last months; finally, he says that the surge in output experienced in the third quarter was a response to the strong demand for the product at that time amongst their customers (Gamal & Ghaddar, 2018). Finally, the Saudi Arabian OPEC governor wraps up the interview by declaring that although they are increasing productivity, they will ensure that they tighten the spare capacity by the same amount (Gamal & Ghaddar, 2018).
These statements show that OPEC and non-OPEC countries were playing at market equilibrium, producing just enough to satisfy the global market, since they know that they have a monopoly on the issue. Firstly, it follows that crude oil supply and demand shocks on the prices profits and output result in an overshooting short-term and long-term effect on the prices; for example, if there is a negative demand on crude oil, it will severely impact the Saudi Arabian economy (Roberto, 2003). However, if there is a positive demand shock, the country does not gain much since it always seeks the OPEC’s approval on increasing oil supply in the market; it is therefore in the self-interest of Saudi to maintain the oil price stable (Roberto, 2003).
Conclusion
The oil industry contains a few oligopoly organizations, namely OPEC and non-OPEC countries, and to avoid unfair competition amongst themselves while maximizing on the profits, they control the global prices. In this particular case, the interplay between supply and demand are carefully observed to ensure that the former is just enough for the worldwide market; arguably, this is done to maintain the prices at just below the spare capacity. It is the stability of these factors that ensure that the price stabilizes, although many other factors can contribute to its fluctuations; arguably, it is these changes in the market that the oil-producing members look out for, and act accordingly. Additionally, when the factor price as determined by supply and the demand maintained in a steady state, the marginal physical productivity can then be used to calculate the resources needed to produce crude oil at its spare capacity.
The article “Saudi Arabia Says Oil Market Could Shift to Oversupply in the Fourth Quarter” delves into how demand and supply relate to the market through marginal products as determined by global oil prices.
Chowdhary, M. (2009) Constraint Management: Throughput, operating expense and inventory. India: Global India Publication.
Du, L., Yanan, H., & Wei, C. (2010). The relationship between oil price shocks and China’s macro-economy: An empirical analysis. Energy policy, 38(8), 4142-4151. doi.org/10.1016/j.enpol.2010.03.042
Gamal, E. R., & Ghaddar, A. (2018, Oct 25). Saudi Arabia Says Oil Market Could Shift to Oversupply in Fourth Quarter, New York Times. Retrieved from http://www.nytimes.com/reuters/2018/10/25/business/25reuters-saudi-oil-opec.htmlDe
Lai, L. W., & Yu, B. T. (2006). The power of supply and demand: Thinking tools and case studies for students and professionals. Hong Kong: Hong Kong University Press.
Santis, R. (2003). Crude oil price fluctuations and Saudi Arabian behavior. Kiel Institute for the World Economy, 25(2), 155-173.
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Published On: 01-01-1970
