Module-12 G as prices : Supply and demand analysis TEACHER’S GUIDE P. 363Defined P. 364Content standards P. 365Materials P. 365Procedure P. 371Lesson outline P. 372Closure P. 372Assessment P. 375Overheads Visuals N Visuals for overhead projector. Copy to transparent paper for overhead. P. 376NVisual-1: Demand for gas P. 377NVisual-2: Supply of gas P. 378NVisual-3: Price ceiling P. 379NVisual-4: Shortage P. 380 NVisual-5: Price gouging P. 381NVisual-6: Supply and demand for gasoline Lessons 2 Copy and handout to students. P. 3842 Lesson-I: Gas price P. 3892 Lesson assessment Gas prices Supply and demand analysis Module-12 Teacher DEFINED Gasoline accounts for 17% of the energy consumed in the United States, primarily used in automobiles and light trucks. Gasoline prices have increased over 60% between 2005 and 2007. This dramatic price increase drew the attention of both politicians and the general citizenry. Furthermore, profits from oil companies refining crude oil into gasoline reached record highs. This led to charges of price gouging. Price gouging is when a seller charges more than a fair price for a good or service. The table below compares the cost of producing gasoline in 2004 and 2005. Notice that refinery costs and profits have increased by $.10 per gallon which is less than 25% of the total price increase. The major contributor to the price increase was the rise in the cost of crude oil, an input into gasoline production. While the $.10 increase from the refinery may include a substantial increase in profits, crude oil cost is obviously having more influence on gasoline prices. As is often the case with economic phenomena, multiple forces affect the price and quantity of the product sold, including hurricanes, war, taxes, and seasons. The economic concepts of supply and demand were introduced in previous modules. This Hot Topic Module will emphasize the importance of understanding the functions of supply and demand, how they change, and the impact of those changes using gasoline and the factors that affect gasoline prices at the pump. production cost of gasoline difference 2004 2005 distribution and marketing .022 .020 -0.02 refinery cost and profits 0.33 0.43 0.10 taxes 0.43 0.43 0.00 crude oil 0.87 1.21 0.34 1.85 2.27 0.41 retail price Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices 363 Gas prices Supply and demand analysis Module-12 Teacher CONCEPTS 1. 2. 3. 4. 5. 6. Supply; change in supply, change in quantity supplied Demand; change in demand, change in quantity demanded Price gouging Entrepreneurship Price ceiling Market equilibrium OBJECTIVES 1. Understand the concepts of supply, demand, and equilibrium. 2. Realize that multiple factors affect the price of gasoline (and other commodities). 3. Realize that price sends signals to producers and consumers. 4. Understand that entrepreneurs are people who take the risks of organizing productive resources to make goods and services. CONTENT STANDARDS National Content Standards in Economics 1. (Standard 1) Productive resources are limited. Therefore, people cannot have all the goods and services they want; as a result, they must choose some things and give up others. 2. (Standard 3) Different methods can be used to allocate goods and services. 3. (Standard 4) People respond predictably to positive and negative incentives. 4. (Standard 5) Voluntary exchange occurs only when all participating parties expect to gain. 5. (Standard 7) Markets exist when buyers and sellers interact. 6. (Standard 8) Prices send signals and provide incentives to buyers and sellers. 7. (Standard 9) Competition among sellers lowers costs and prices, and encourages producers to produce more of what consumers are willing and able to buy. 8. (Standard 14) Entrepreneurs are people who take the risks of organizing productive resources to make goods and services. 364 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices Gas prices Supply and demand analysis Module-12 Teacher Montana Social Studies Content (Standard 5) 1. (Benchmark 1) Identify and explain basic economic concepts. 2. (Benchmark 2) Use basic economic concepts to explain current and historical events. 3. (Benchmark 5) Explain and illustrate how money is used by individuals and groups. 4. (Benchmark 6) Understand the effects of new technology, global interdependence, and competition on individuals and the development of national policy. TIME REQUIRED 1-2 class periods MATERIALS Overhead projector Transparency pen NVisuals for overhead projector: Copy to transparency. NVisual-1: Demand for gasoline NVisual-2: Supply of gasoline NVisual-3: Price ceiling NVisual-4: Shortage NVisual-5: Price gouging NVisual-6: Supply and demand for gasoline Lesson worksheets: Copy for each student: 2 Lesson-I: Gasoline price 2 Lesson assessment PROCEDURE 1. Talk with students about the price of gasoline at the pump. LQuestion: Do students believe the price of gasoline is too high? Why? LQuestion: Do they believe the price of gasoline is too low? Why? Display NVisual-1: Demand for Gasoline. Answer: Remind students that the quantity consumed reflects the price at the pump. When the price is higher the quantity consumed is Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices 365 Gas prices Module-12 Teacher Supply and demand analysis less. Demonstrate this with a leftward movement along the demand curve. A lower price encourages more consumption. Show students this rightward movement along the demand curve on the visual. Remember, a fluctuation in price results in a change in quantity demanded and is shown as a movement along the curve. 2. Discuss with students the fact that gasoline accounts for 17% of the energy consumed in the United States. It is primarily used in automobiles and light trucks. Other energy sources include hydro power and coal. 3. Display NVisual-2: Supply of gasoline. Remind students that as price increases, producers are willing to increase the quantity supplied. This can be shown as a rightward movement along the supply curve. Of course a decrease in price will decrease the quantity that producers are willing to supply, shown as a leftward movement along the supply curve. 4. Talk for a moment about the role of entrepreneurs. Entrepreneurs (producers) are people who take risks by organizing productive resources to make goods and services. They take risks because they believe they will receive profits in return. 5. Now demonstrate what happens if the price of gasoline is held artificially low through the use of a price ceiling. This is shown in NVisual-3: Price ceiling for gasoline. A price ceiling is a government mandated maximum price designed to keep the product affordable. It is illegal to charge above the price ceiling. Use your hand to show a ceiling that cannot be pushed up. A price ceiling can be compared to the below equilibrium wage for babysitters demonstrated in Module-9: Equilibrium. When price is held artificially low, consumers of gasoline, like parents when babysitting wages were low, want to purchase more than is available in the market. The quantity demanded is then determined by the point where the price intersects the demand curve. Producers, comparable to the babysitters in Module 9, would not be willing to provide as much or to invest in future development. The quantity supplied will be the quantity determined by the point where the price ceiling intersects the supply curve. In order for a price 366 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices Gas prices Supply and demand analysis Module-12 Teacher ceiling to be effective, it must be set below the market equilibrium price. (This is confusing to some students.) The ceiling is below the equilibrium price. If it were above, the market equilibrium price would be charged and the price ceiling would be ineffective. In the early 1970s the U.S. government imposed a price ceiling on gasoline. You may recall the long lines that resulted. Gasoline lines in California reached five miles long. 6. Display NVisual-4: Production. Walk students through the production process. Gasoline is refined from crude oil usually at large refineries and then distributed through pipelines for eventual sale through about 170,000 gasoline stations throughout the United States. The prices paid at the pump reflect the cost of producing gasoline and taxes. Gasoline prices increased over 60% between 2005 and 2007. 7. Remind students that profits can be calculated by subtracting total costs (TC) from total revenues (TR). Total revenues (TR) are the price charged (P) times the quantity consumed (Q). The recent gasoline price increases have resulted in increased profits for oil companies. In fact, profits from oil companies that transform crude oil into gasoline have been at record highs. This has led to charges of price gouging. Total Revenues = Price x Quantity TR = P x Q Profit = Total Revenue-Total Cost Profit = TR-TC 8. Display the top half of NVisual-5: Price Gouging. Discuss the concept with students. price gouging is a pejorative term used to describe high prices seen as ‘unfair’ that may lead to excessive profits for the seller. LQuestion: Are gasoline producers price gouging? Answer: Not necessarily. Remember, that for a transaction to take place, both seller and buyer must agree to the trade, hence both parties perceive gains. It may seem unfair, for example, to sell a house for $30,000 more than the purchase price a few years prior, but market conditions have likely changed. Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices 367 Gas prices Supply and demand analysis Module-12 Teacher LQuestion: Ask students if they believe that it is price gouging when the price of gasoline rises before a summer holiday? Why or why not? Answer: Some may perceive this as price gouging, others not. With nearly 170,000 gasoline stations across the nation it is unlikely that gasoline stations are gouging. (It is illegal in the United States for competitors to agree upon a sales price.) LQuestion: If it is assumed that price gouging is occurring, is government price setting (a price ceiling) going to resolve the problem? Answer: As demonstrated before, a price ceiling encourages increased consumption and will discourage producers from investing in future supplies which is likely to exacerbate the problem. 9. Uncover the table on the bottom half of NVisual-5: Price gouging. The table compares the cost of producing gasoline in 2004 and 2005. Notice that refinery costs and profits have increased by $.10 per gallon. This is less than 25% of the total price increase. Discuss the other factors that have contributed to the increase in gasoline price. The major contributor is the increase in the cost of the crude oil, an input into gasoline production. While the $.10 increase from the refinery may include a substantial increase in profits, crude oil cost is obviously having more influence on gasoline prices. As is often the case with economic phenomena, multiple forces affect the price and quantity of the product sold. Supply and demand concepts help us understand each of these influences. The topics that relate to gasoline prices are innumerable. 10.The following ten issues are just some of the factors that influence gasoline price. Using NVisual-6: Supply and demand for gasoline, graphically illustrate the market impacts of each influence on gasoline price and quantity. You may wish to show two different changes on the same graph to demonstrate the combined effects. a Hurricane Katrina: In late August of 2005, Hurricane Katrina devastated the western United States coast of the Gulf of Mexico. The hurricane area covered about 25% of US crude oil production and over 10% of the United States refining capacity. Pipelines and other distribution systems were damaged and operating at reduced levels. Days after the 368 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices Gas prices Module-12 Teacher Supply and demand analysis hurricane, emergency energy reserves were released. Katrina decreased supply causing the supply curve to shift to the left and increasing price (this would cause a decrease in quantity demanded). The release of the emergency reserves then shifted the supply curve to the right partially compensating for the losses due to Katrina. b.Iraq War: More than 2 million barrels of oil production per day came from Iraq before the United States intervention. In 2003, the year of the intervention, oil production dropped to 1.3 million barrels per day. The immediate response was a leftward shift of the supply curve for gasoline resulting in a higher price and lower quantity of gasoline. Over time, the supply curve has increased, shifting to the right. Today, about the same amount of oil is produced in Iraq as before intervention. It is likely that without intervention the supply of oil would be even greater today and the supply curve for gasoline would be further to the right resulting in lower gasoline prices. It has been predicted that Iraq’s production could reach 9 million barrels per day by 2012 with the development of a new oil field in northern Iraq. This would shift the supply curve for gasoline further to the right. c.Rapid economic growth in China: For the last several years incomes in China have been increasing around 10% per year. This prolonged rapid growth in China has almost continuously increased the worldwide demand for gasoline. Show a series of rightward shifting demand curves with the resulting increasing prices. (Note that the quantity supplied will also continue to increase.) d.United States refinery capacity: The last major refinery built in the United States was constructed in 1978. Federal and state policies have increased the expense and time to build new refineries. However, since 1978, income (purchasing power) has increased substantially and population has increased by about a third. How will the United States meet its future energy needs? The supply from U.S. refineries has not changed; U.S. refinery capacity has not changed. U.S. policies and other factors have prevented the supply curve from shifting to the right. The increases in both income and population have shifted demand to the right. This causes price to increase and the Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices 369 Gas prices Module-12 Teacher Supply and demand analysis quantity supplied to increase. Of course, the quantity supplied can only increase with imports since U.S. refinery capacity has remained constant. The additional supplies that come from abroad come at a higher cost because of the high costs of transporting refined products. This causes the supply curve to shift farther left than would have occurred with domestic production. e.Environmentally sensitive potential oil production regions: Oil drilling and production has been barred from the Arctic National Wildlife Refuge (ANWR), a National Wildlife Refuge in northeastern Alaska, and other areas of the United States. These areas have been considered environmentally important and particularly sensitive to adverse impacts from drilling. Demonstrate the effect of restricted drilling on the quantity and price of gasoline. The restrictions have the potential to reduce the supply if slowing production in one area cannot be met with increased production in another. This would be shown as a leftward shift in supply causing price to increase and the quantity demanded to decline. f. Phase out of MTBE (methyl tertiary butyl ether) is a gasoline additive that enhances octane (gasoline mileage) and reduces emissions. However, MTBE is a threat to groundwater quality and therefore poses a potential liability. MTBE is being phased out and replaced with other additives. If these replacement additives are more expensive what will happen to the gasoline market? The increased cost of gasoline additives increases the cost of production, hence shifting the supply curve to the left. Price will also rise and quantity demanded will decline. g.Development of mass transit: With the higher price of gasoline, there has been discussion of the expansion of mass transit systems in larger metropolitan areas and the development of systems in areas without current mass transit. If mass transit is a substitute for private vehicles it could help reduce the demand for gasoline. This would be shown as a leftward shift of the demand, price would decline and the quantity supplied would decline. h.Ethanol production: The Federal and some state governments provide substantial subsidies to produce ethanol from corn or other agricultural products. The ethanol is mixed with 370 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices Gas prices Supply and demand analysis Module-12 Teacher gasoline thereby replacing a portion of the gasoline. Specially designed cars may use mixtures of up to 85% ethanol. Ethanol helps replace a portion of the gasoline. Every else constant, this would shift the demand for gasoline to the left. However, ethanol production requires the use of energy, often in the form of gasoline. Hence, the production of ethanol alone, would shift the demand for gasoline to the right. The end result putting the two changes together would depend upon which shift is larger. i. Coal: Substantial electricity is produced from crude oil that could be used to produce gasoline. Development of known United States coal reserves has been hampered by a variety of environmental regulations and policies. How would less restrictive policies on coal development affect the gasoline market? If more coal was available for electricity production this would decrease the demand for crude oil lowering its price. A lower price for crude oil, an input in gasoline production, would cause a rightward shift of the gasoline supply curve. In turn, this would decrease the price of gasoline and increase the quantity demanded. j. Government Price Controls: Around the world many nations have moved toward a market based economy. Previously, prices were set by their governments. Usually these prices were set lower than what the market price would have been if allowed to reflect the true price for gasoline. Price ceilings that restrict a price below its market price encourage a greater quantity demanded than the equilibrium level and a lower quantity supplied. LESSON Outline Lesson-I: Gasoline Price The lesson includes ten more issues that will have an impact on gasoline prices. Either in class or as a take home assignment, have students draw the change in supply, demand, and/or price for each issue. The issues follow: a.Development of wind energy Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices 371 Gas prices Supply and demand analysis Module-12 Teacher b.Development of fuel efficient cars c.Increased political squabbles between nations d.New technology to produce oil from cattle and hog manure e.Land use planning to restrict urban sprawl f. Instability in Iran g.9/11 attack lowers incomes h.Federal, state, and local taxes on gasoline i. Alaskan pipeline repair j. Exxon Valdez oil spill CLOSURE Review the lesson by asking the following questions: 1. LQuestion: Why do gasoline prices change? Answer: There are many factors that influence the price of gasoline. These include supply shocks like Hurricane Katrina, and demand shocks like a heat wave. Changes in the costs of production, changes in consumer income, and changes in technology are a few more. 2. LQuestion: Are gasoline companies price gouging? Answer: Generally, gasoline companies charge the market rate for gasoline. The fact that other circumstances have changed has led to an increase in profits for gasoline refineries. This rise in profitability has also encouraged more research and development in gasoline resources which should lead to increased supply in the future. ASSESSMENT Multiple-choice questions 1. LQuestion: What determines the price of gasoline charged at the pump? a.Many factors influence the price of gasoline. b.Producers negotiate to determine the best price for all to charge. c.The limited supply of gasoline. Because it is limited the price will always increase. d.Taxes are the overriding factor affecting gasoline prices. 372 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices Gas prices Supply and demand analysis Module-12 Teacher 2. LQuestion: Hurricane Katrina caused a/an: a.decrease in the price of gasoline resulting from a decrease in supply. b.increase in the price of gasoline resulting from a decrease in supply. c.increase in the quantity demanded from an increase in supply. d.increase in the price of gasoline resulting from an increase in supply. 3. LQuestion: What is likely to happen to gasoline prices as a result of rapid economic growth in China? a.An increase in price as a result of increased demand. b.A decrease in price as a result of a decrease in demand. c.An increase in price as a result of an increase in supply. d.A decrease in price as a result of a decrease in supply. 4. LQuestion: Which of the following will likely occur as the result of new technologies and alternative fuels that are competitive with the price of gasoline? a.An increase in the demand for gasoline. b.A decrease in the demand for gasoline. c.An increase in the supply of gasoline. d.An increase in the quantity supplied of gasoline. 5. LQuestion: How will consumers respond to a dramatic increase in gasoline price? a.There will be an increase in quantity demanded. b.There will be a decrease in quantity demanded. c.There will be an increase in demand. d.There will be a decrease in demand. Answers: 1. 2. 3. 4. 5. a b a b b Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices 373 Gas prices Supply and demand analysis Module-12 Teacher Discussion/essay questions 1. LQuestion: Are gasoline prices likely to increase or decrease in the future? Explain. Answer: In a world full of uncertainty gasoline prices are likely to continue to fluctuate. Natural disasters like Hurricane Katrina, conflicts in high oil producing regions, and restrictive regulations will put upward pressure on price. Alternative fuel sources like ethanol, solar, and wind power have the potential to reduce demand for gasoline putting downward pressure on price. 2. LQuestion: Alternative fuels like wind and solar power are developing at a rapid pace. As these fuels become competitive with gasoline, what is the likely impact on the supply and demand of gasoline? Answer: Alternative fuels would be a substitute for gasoline. As these fuels become cheaper consumers will shift away from gasoline, decreasing the demand for gasoline. This will cause a decrease in price and a decrease in the quantity supplied. NOTES ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ 374 ___________________________________________________ Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices ___________________________________________________ ___________________________________________________ Module-12 O ver h ead visuals Gas prices Gas prices Supply and demand analysis Module-12 Visual Visual-1: demand for gasoline a change in quantity demanded: a movement along the demand curve in response to a change in price. p = price q = quantity d = demand N376 Gas prices Module-12 Visual Supply and demand analysis Visual-2: SUPPLY of gasoline a change in quantity supplied: a movement along the supply curve in response to a change in price. p = price q = quantity d = demand N377 Gas prices Supply and demand analysis Module-12 Visual Visual-3: price ceiling for gasoline price ceiling a maximum price that can be charged for goods or services. p = price N378 q = quantity d = demand S = SUPPLY Gas prices Supply and demand analysis Module-12 Visual Visual-4: Shortage 1. pumping the crude oil from the ground. 2. transporting the crude oil to the refinery 3. refining the crude oil into gasoline, diesel, motor oil, etc. 4. transporting the gasoline to service stations 5. selling the gasoline to consumers remember N379 Gas prices Supply and demand analysis Module-12 Visual Visual-5: price gouging production cost of gasoline difference 2004 2005 distribution and marketing .022 .020 -0.02 refinery cost and profits 0.33 0.43 0.10 taxes 0.43 0.43 0.00 crude oil 0.87 1.21 0.34 1.85 2.27 0.41 retail price N380 Gas prices Supply and demand analysis Module-12 Visual Visual-6: supply and demand for gasoline illustrates the market impact on gasoline price and quantity. p = price q = quantity d = demand S = SUPPLY N381 Gas prices Supply and demand analysis Module-12 Teacher NOTES ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ 382 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices Module-12 L es s on w o r ks heets Gas prices Gas prices Supply and demand analysis Module-12 Lesson Lesson-I: Gas Price Using the following supply and demand diagrams illustrate how each factor will affect the price of gasoline and quantity consumed. Label any new curves, changes in price, and changes in equilibrium quantity. 1. Development of wind energy P (price per gallon) S1 P1 D1 Q1 Q (gallons) 2. Development of fuel efficient car P (price per gallon) S1 P1 D1 Q1 384 2 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices Q (gallons) Gas prices Supply and demand analysis Module-12 Lesson Lesson-I: Gas Price 3. Increased political squabbles between nations P (price per gallon) S1 P1 D1 Q1 Q (gallons) 4. New technology to produce oil from cattle and hog manure P (price per gallon) S1 P1 D1 Q1 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices Q (gallons) 2385 Gas prices Supply and demand analysis Module-12 Lesson Lesson-I: Gas Price 5. Land use planning to restrict urban sprawl P (price per gallon) S1 P1 D1 Q1 Q (gallons) 6. Instability in Iran P (price per gallon) S1 P1 D1 Q1 386 2 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices Q (gallons) Gas prices Supply and demand analysis Module-12 Lesson Lesson-I: Gas Price 7. 9/11 Attack lowers incomes P (price per gallon) S1 P1 D1 Q1 Q (gallons) 8. Federal, state, and local taxes on gasoline P (price per gallon) S1 P1 D1 Q1 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices Q (gallons) 2387 Gas prices Supply and demand analysis Module-12 Lesson Lesson-I: Gas Price 9. Alaskan pipeline repair P (price per gallon) S1 P1 D1 Q1 Q (gallons) 10. Exxon Valdez oil spill P (price per gallon) S1 P1 D1 Q1 388 2 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices Q (gallons) Gas prices Supply and demand analysis Module-12 Lesson Lesson assessment Multiple-choice questions 1. LQuestion: What determines the price of gas charged at the pump? a.Many factors influence the price of gasoline. b.Producers negotiate to determine the best price for all to charge. c.The limited supply of gasoline. Because it is limited the price will always increase. d.Taxes are the overriding factor affecting gas prices. 2. LQuestion: Hurricane Katrina caused a/an: a.Decrease in the price of gas resulting from a decrease in supply. b.Increase in the price of gas resulting from a decrease in supply. c.Increase in the quantity demanded from an increase in supply. d.Increase in the price of gas resulting from an increase in supply. 3. LQuestion: What is likely to happen to gas prices as a result of rapid economic growth in China? a.An increase in price as a result of increased demand. b.A decrease in price as a result of a decrease in demand. c.An increase in price as a result of an increase in supply. d.A decrease in price as a result of a decrease in supply. 4. LQuestion: Which of the following will likely occur as the result of new technologies and alternative fuels that are competitive with the price of gas? a.An increase in the demand for gas. b.A decrease in the demand for gas. c.An increase in the supply of gas. d.An increase in the quantity supplied of gas. 5. LQuestion: How will consumers respond to a dramatic increase in gas price? a.There will be an increase in quantity demanded. b.There will be a decrease in quantity demanded. c.There will be an increase in demand. d.There will be a decrease in demand. Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices 2389 Gas prices Supply and demand analysis Module-12 Lesson Lesson assessment Discussion/essay questions 1. LQuestion: Are gas prices likely to increase or decrease in the future? Explain. 2. LQuestion: Alternative fuels like wind and solar power are developing at a rapid pace. As these fuels become competitive with gasoline, what is the likely impact on the supply and demand of gasoline? 390 2 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices Gas prices Supply and demand analysis Module-12 Answer Lesson-I: Answer Key Using the following supply and demand diagrams illustrate how each factor will affect the price of gasoline and quantity consumed. Label any new curves, changes in price, and changes in equilibrium quantity. 1. Development of wind energy Answer: When alternative fuels become price competitive with gasoline the demand for gas will decrease. The alternative fuels are a substitute for gasoline. The result is a decrease in price and a decrease in quantity supplied. P (price per gallon) S1 P1 P2 Q 2 Q1 D2 D1 Q (gallo ns) 2. Development of fuel efficient car Answer: As consumers begin to buy more fuel efficient cars, everything else constant, they will consume less gasoline. The outcome of this alone will be a decrease in the demand for gas, a decrease in price, and a decrease in quantity supplied. Evidence shows, however, that as consumers realize they can drive further on a gallon of gas they begin to drive more. Each mile driven is relatively cheaper than before. As a result the decrease in demand for gas may not be as much as expected. P (price per gallon) S1 P1 P2 Q 2 Q1 D2 D1 Q (gallo ns) Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices 2391 Gas prices Supply and demand analysis Module-12 Answer Lesson-I: Answer Key 3. Increased political squabbles between nations Answer: The answer here, of course, depends upon the circumstances among the squabbling nations. The difficulties in the Middle East, however, have had an impact on gas price. More than 2 million barrels of oil production per day came from Iraq before the United States intervention, for example. In 2003, the year of the intervention, oil production dropped to 1.3 million barrels per day. The immediate response was a leftward shift of the supply curve for gasoline resulting in a higher price and lower quantity demanded of gasoline. Over time, the supply curve has increased, shifting to the right. Today about the same amount of oil is produced in Iraq as before intervention. It is likely, that without intervention, the supply of oil would be even greater today and the supply curve for gasoline would be further to the right resulting in lower gas prices. It has been predicted, that Iraq production could reach 9 million barrels per day by 2012 with the development of a new oil field in northern Iraq. This would shift the supply curve for gasoline further to the right. P S2 (price per gallon) S1 P2 P1 D1 Q 2 Q1 Q (gallo ns) 4. New technology to produce oil from cattle and hog manure Answer: When alternative fuels become price competitive with gasoline the demand for gas will decrease. The alternative fuels are a substitute for gasoline. The result is a decrease in price and a decrease in quantity supplied. P (price per gallon) S1 P1 P2 Q 2 Q1 D2 D1 Q (gallo ns) 392 2 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices Gas prices Supply and demand analysis Module-12 Answer Lesson-I: Answer Key 5. Land use planning to restrict urban sprawl Answer: Everything else constant, if people desired to drive less as a result of more convenient and accessible goods nearby, they would also desire less of the complements to driving, such as gasoline. Demand for gas would decrease, shown by a shift to the left. Prices would decline and the quantity supplied would also fall. P (price per gallon) S1 P1 P2 Q 2 Q1 D2 D1 Q (gallo ns) 6. Instability in Iran Answer: Iran is one of the world’s gas giants. Decreased production in Iran would result in a decrease in the supply of gas, a leftward shift. Price would increase and the quantity demanded would decline. P S2 (price per gallon) S1 P2 P1 D1 Q 2 Q1 Q (gallo ns) Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices 2393 Gas prices Supply and demand analysis Module-12 Answer Lesson-I: Answer Key 7. 9/11 Attack lowers incomes Answer: A decline in income causes a decrease, or leftward shift, of the demand curve. As a result price will also fall and the quantity supplied will decrease. P (price per gallon) S1 P1 P2 Q 2 Q1 D2 D1 Q (gallo ns) 8. Federal, state, and local taxes on gasoline Answer: A tax on producers will result in a leftward shift, a decrease, of the supply curve. Price will increase and quantity demanded will fall. The new market price will be P2. The producer must then pay the per unit tax which is equal to the vertical distance between the old supply (S1) and the new supply curve (S2), or the difference between P2 and P3. Both the producer and the consumer pay a portion of the tax. Consumers now pay P2 which is greater than the original price of P1. The producer only retains P3 because the amount P2 minus P3 is the per unit tax that must be paid to the government. A tax placed on the consumer would have the same end result but instead of decreasing the supply curve the demand curve would shift to the left by the amount of the per unit tax. Consumers would pay price P3 and then pay the per unit tax of P2 minus P3 to the government. The total price paid by consumers would be P2 and the amount received by producers would be P3. P S2 (price per gallon) S1 P2 P1 P3 D1 Q 2 Q1 Q (gallo ns) 394 2 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices Gas prices Supply and demand analysis Module-12 Answer Lesson-I: Answer Key 9. Alaskan pipeline repair Answer: Repairing corrosion and rust on the Alaska pipeline is estimated to cost as much as $1 billion and may require temporarily shutting the valves on part of the nation’s largest oil field. The short term result would be a decrease in supply, increasing price and reducing quantity demanded. P S2 (price per gallon) S1 P2 P1 D1 Q 2 Q1 Q (gallo ns) 10. Exxon Valdez oil spill Answer: In 1989 the Exxon Valdez tanker ran aground spilling more than 10 million gallons of oil into Alaska’s Prince William Sound. In addition to the immediate reduction in supply available for gas refining, Exxon has paid billions in retribution. Together these actions are shown by a decrease, or leftward shift, of the supply curve. A decrease in supply will cause an increase in price and a decrease in quantity demanded. P S2 (price per gallon) S1 P2 P1 D1 Q 2 Q1 Q (gallo ns) Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices 2395 Gas prices Supply and demand analysis Module-12 Teacher NOTES ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ ___________________________________________________ 396 Copyright © 2008 by MCEE (www.econedmontana.org) Economics: The Study of Choices