Question

Price (cents per gallon) 90 100 110 120 130 140 150 Quantity Demanded (thousand gallons per week 80 70 60 50 40 30 20 Quantity Supplied (thousand gallons per week 20 30 40 50 60 70 80 A market research team has come up with the demand and supply schedules for gasoline in Motorville in the table above. Use these data to analyze the situation in the market for gas in Motorville a) Draw a figure showing the demand curve for gasoline and the supply curve of gasoline. What are the equilibrium price and quantity? (5 marks) Suppose the price is $1.30. Describe the situation in the market and explain how the market adjusts Now suppose the price is $1.00. Describe the situation in the market and explain how the market adjusts. (10 marks) b) c) The market research report also predicts that a rise in the price of crude oil will decrease the quantity of gas supplied by 20,000 gallons a week at each price. Suppose the price of crude oil does rise. Use your figure to show how this will affect the market for gas. How will the market adjust? What will be the new equilibrium price and quantity? (10 marks)

Answer 1

a) The demand and supply of gasoline is

The equilibrium occurs where demand and supply intersects. The curves intersects at E1. The equilibrium quantity is 50,000 and price is 120 cents or $1.20.

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b)

The equilibrium price in the gasoline market is $1.20. The price level $1.30 is higher than $1.20. At $1.30 the supply of gasoline is 60,000 and that of demand is 40,000. Then in the market demand is lower than the supply. Therefore, there exists excess supply in the market. The excess supply is called surplus. In case of surplus there would be some producers who will be willing to supply the good at lower prices in order to sell the surplus. Therefore, the price in the market would fall. The fall in price will increase the quantity demanded of the good. Then the gap between supply and demand will fall and eventually comes to zero. The price will seize to fall after that.

Similarly, the price level $1.00 is lower than $1.20. At $1.00 the supply of gasoline is 30,000, and that of demand is 70,000. Then in the market demand is higher than the supply. Therefore, there exists excess demand in the market. The excess demand is called a shortage. In case of shortages, there would be some consumers who will be willing to buy the good at higher prices to get gasoline. Therefore, the price in the market would rise. The rise in price will increase the quantity supplied of the good. Then the gap between supply and demand will fall and eventually comes to zero. The price will seize to rise after that.

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c)

After the fall in supply, the new supply curve becomes Supply 2. The new supply curve is depicted in the figure above. The quantity supplied fall by 20,000 at each price. The new schedule is given as

Price	QD	QS	QS2
90	80	20	0
100	70	30	10
110	60	40	20
120	50	50	30
130	40	60	40
140	30	70	50
150	20	80	60

Now at the new equilibrium price of 130 cents, there will be a shortage. The shortage will bid the price high. The rise in price will decrease quantity demanded, and the market will reach a new equilibrium at E2. At the new equilibrium, the quantity is 40,000, and the equilibrium price is $1.30 or 130 cents.