Question

3. Consider the market for oil. What do we expect to happen to the equilibrium price and quantity in

each of these situations?

(a) New drilling technology makes oil extraction more economical at any given price

(b) The economy improves more than expected and people drive more

(c) Battery technology drives down the price of electric cars, while simultaneously major oil fields

begin to decline in production

(d) Engineers make gas using cars more efficient, while simultaneously the demand for natural gas

(which is produced complementary to petroleum) increases

Answer 1

(a) Oil extraction becoming more economical, production cost decreases, so oil firms increase supply. This shifts supply curve rightward, decreasing price and increasing quantity of oil.

(b) When people drive more, demand for oil (as fuel) increases. Demand curve shifts right, increasing both price and quantity of oil.

(c) Lower price of electric cars, a substitute for gas-fueled cars, decreases demand for gas-fueled cars and so, decreases demand for oil. Demand for oil shifts left, decreasing price and decreasing quantity. At the same time, decline in oil production lowers oil supply, shifting supply curve left, increasing price and decreasing quantity. As the net effect, quantity definitely decreases, but net effect on price is uncertain.

(d) More efficient gas-driven cars increases mileage and decreases oil demand. Demand for oil shifts left, decreasing price and decreasing quantity. At the same time, demand for natural gas rises, decreasing the supply of oil, shifting supply curve left, increasing price and decreasing quantity. As the net effect, quantity definitely decreases, but net effect on price is uncertain.