Question

ECO122( Discussion Board)

Please use the concepts of determinants of demand and supply and complex cases (found in Chapter 3) to solve the following problem.
Assume, over time, consumer incomes generally increase but also that technological advancements in oil extraction lead to lower prices of crude oil (the primary input for gasoline).
If consumer incomes increase by significantly more than input prices fall, what happens to both the equilibrium price and quantity of gasoline? Remember the market is gasoline, not oil.
If you find it easier to upload a graph to support your written answer please feel free to do so.

Answer 1

Answer 1:

Increase in the income of the consumer will increase the demand for gasoline as gasoline is a normal good and quantity demanded is positively related to income. On the supply side, fall in the price of input will reduce the cost of production of gasoline and thus increase quantity supplied of gasoline at each price level. It can be depicted in the graph below:

no sŚ quice at Tel ? Gasoline de Quantity of Caroline

The initial equilibrium in the market for gasoline occurs at point E1. Increase in income has led to rightward shift of the demand curve to D'D' and fall in input price has shifted the supply curve rightwards to S'S' and shift in the demand curve is more than the shift in the supply curve such that the new equilibrium occurs at point E2 where the equilibrium amount of quantity demanded has increased to OQ2 and equilibrium price level has also increased to OP2.