The Saudis are learning the economics of perfect competition–Price equals Marginal Cost.

Oil took a dive south again this week, going below $50/barrel yesterday.  As we’ve discussed before, the American “fracker” is now the marginal supplier–ready to turn on the spigots at the first sign of a higher price.  In an introductory Econ course, we’ll review what is often called “perfect competition,” or more appropriately, a price-taker market.   One of the central tenets of this model is that it will be characterized by price equaling the marginal cost.  So if the marginal cost of production is $45, and the current market price is $50, production will expand until the price equals marginal cost.

The Saudi’s big gamble was that they could kill the American fracker, and they failed in that effort.  This week’s price action in the market price of oil simply confirmed this thesis:  U.S. stockpiles of oil rose dramatically despite the ongoing OPEC output cuts.  Further, the frackers are moving out with big expansion plans in the months ahead.  The price of oil will no longer be determined (at least over the longer term) by OPEC.  The price will be determined by the marginal cost of the American frackers–and that cost continues to decline.    And with “open up the pipelines” Trump (provided they use U.S. steel!) in charge, this is likely to be the case going forward.

I haven’t felt this good about oil since 1986, when the price of a gallon of gas fell from $1.50 to $.50.   With the price of oil likely not covering the Saudis’ cost of governance, perhaps they won’t have $$ to send to madrassas across the world to foment jihad?

10 thoughts on “The Saudis are learning the economics of perfect competition–Price equals Marginal Cost.”

  1. Great Post Dr. Haymond!

    Love the implications this has. Despite our Governments best efforts to prop up the House of Saud, it may be the market that actually plants the seed of their fall!

  2. I like the reminder of the economics. Remind us of what we are learning is real in the world and happens every day/week.

  3. Shockingly, microeconomics is once again validated. The Saudis seem to be losing the prestige and control, which may be welcome on the jihad front (though I’m not sure this is necessarily good for the stability in the region). This also seems to confirm the resource curse that befalls countries like Saudi Arabia and Russia. Living off the fat of the land only gets us so far.

  4. Great post that highlights how textbook economics will work in the real world. I also feel good about oil in a way that hasn’t been seen in a long time, as the prices are finally being determined by free supply and demand rather than cartels.

  5. I appreciate this article because it is relevant to what is happening in our economy. I personally don’t stay educated on the oil but this was very interesting to read about. It is nice to know that we can start feeling good about the oil again. I like reading about what is going on in our current economy, it helps me apply textbook economics to the real world.

  6. Really enjoyed reading this post! How long do you honestly think it will for frackers to take over the oil industry?

  7. Loved getting to read a real world example about what we have already learned in class. This makes the concepts much easier to understand and be able to apply. Do you think the Saudis will cave or do you think they will be persistent in the oil industry?

  8. So much appreciate how you take a current event and apply it to basic economic principles. It is exciting to see what will happen in the long term.

  9. It’s pretty awesome to see your prediction from a blog post from just a couple of months ago come to fruition! It’s also really cool to see basic, first-semester level concepts play out on a global scale.

  10. Awesome seeing this applicable example of economics. We read about it in the textbooks, but understanding it in terms of the real world is cool to see. I often hear my parents talk about the 80’s and how the price of gas fell so dramatically. Whenever the price starts dropping now, they like to refer to 1986 in hopes of it becoming much lower again. It will be interesting to see how the frackers further impact the oil industry.

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