South-Western College Publishing - Economics  
Higher Gasoline Prices Fuel Debate Over Causes
Subject Comparative Statics
Topic Supply and Demand/Equilibrium
Key Words Price, Wholesale Prices, Demand, OPEC, Production, Cost
News Story

In a matter of two weeks, the price of gasoline at the pumps has risen by eight cents to a national average of $1.08 a gallon. The increase is the fastest since the Persian Gulf War in 1990.

Retailers have raised their prices because refiners have increased wholesale prices. This has been made possible by the demand for gasoline, which is very high because of the strong economy, seasonal increases in driving, and the increased use of gas-guzzling cars such as sport-utility vehicles.

One industry economist stated that the increase reflects the higher price of crude oil and the seasonal introduction of gasoline that pollutes less but costs more to make. However, while the Organization of Petroleum Exporting Countries (OPEC) is planning to cut back their production of oil in an attempt to increase its price, it has not reached final agreement. Hence the wholesale price increase cannot be blamed on the oil producers. The price that refiners paid for the crude oil that was used to produce the gasoline currently being sold was in fact quite low.

Drivers are seeing the cost of driving increase. Businesses that rely on transportation are seeing their costs rise. However, there is little sign of consumers cutting back as yet.

(Updated May 1, 1999)

Questions
1. Draw a price-quantity diagram of the market for refined oil. Mark the initial equilibrium price. According to the industry economist, the price increase is due to the higher price of crude oil and the more costly production of lower-pollution refined oil.
  a)Show how the increase in the equilibrium price occurs according to this account.
  b)What will be the effect on the equilibrium quantity of refined oil?
  c)How does your prediction in (b) compare with the news story regarding the quantity of gasoline purchased? How do you explain this?
2. Draw a further supply and demand diagram of the market for refined oil. Show the initial equilibrium. Another interpretation of what is happening is that the demand for refined oil has increased.
  a)Which determinants of demand have changed?
  b)Illustrate the consequences for the curves and the equilibrium on your diagram.
  c) How does the change in the equilibrium price and quantity of refined oil compare with the news story regarding the price and quantity of gasoline purchased? Which of the two accounts of the price increase is more plausible?
3. Businesses which rely on transportation, such as vans and trucks, are seeing their costs increase. What will be the effect on the equilibrium prices and quantities of their products? Illustrate your answer.
Source Agis Salpukas, "Gas Prices Rise 8 Cents at Pump In Two Weeks", The New York Times, March 23, 1999.

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