Oil Producers Pump Up The Volume
Subject Comparative statics
Topic Equilibrium
Key Words Prices, OPEC, output, wholesale prices, retail prices, competition
News Story

Gasoline prices are collapsing so fast that drivers could soon be paying less than 80 cents a gallon. The decline may continue because the Organization of Petroleum Exporting Countries (OPEC) has decided that as non-OPEC countries are unwilling to curb production, neither will OPEC reduce its output. Crude oil prices hit $30 a barrel on September 11, but have since fallen as low as $16.80. Wholesale gasoline prices are a mere 44.5 cents. Retail gasoline prices may fall to less than 70 cents by Christmas as a result.

Lower prices at the pump are expected to increase driving. That suits those who have turned to driving due to heightened airline security. Local competition between retailers has added to the pressure on gasoline prices.

Of course, there is still a lot of regional variation in gasoline prices. For example, in California, prices are cheaper in Los Angeles and Long Beach, averaging $1.26 a gallon, than in the north, such as in San Francisco where the average is $1.76 a gallon. Only Hawaii is higher, with prices averaging $1.83. These prices compare with a current national average of $1.20 a gallon.

(Updated December 1, 2001)

1. Draw a supply and demand diagram of the market for crude oil. Mark the equilibrium price and quantity.
a) Show what would have happened to the equilibrium price and quantity had OPEC and non-OPEC producers been able to agree on output reductions.
b) In practice, they were unsuccessful. Show the likely result on your diagram, and explain what you have drawn.
c) The author of the news story states that the lower prices are expected to encourage more driving. Explain this in terms of your diagram and your last answer. Would there be a change in demand or quantity demanded? Why?
2. Now draw a supply and demand diagram of the market for gasoline. Show the effect on the equilibrium price and quantity of the following, and state which determinant of demand or supply has changed:
a) heightened airport security
b) greater competition between local gasoline retailers
3. Why are there such great regional differences in gasoline prices? Consider the determinants of supply and demand. Draw a supply and demand diagram to illustrate your hypotheses.
Source James R. Healey, "Gas prices could skid below 80 cents," USA Today, November 16, 2001

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