Step 4 – Supply, Demand and Equilibrium
Now we assume that currently the market is in equilibrium. You have derived the oil supply curve (step three), and will determine the current quantity of oil demand, the current price, and the demand equation in the steps below.
Comprehension
1) What factors influence consumer demand for oil?
2) What happens to demand if the price is raised?
3) What happens to demand if the price is lowered?
4) What might cause a surplus of oil?
5) What might cause a deficit of oil?
Acquisition
Some of the concepts introduced in this section (demand, equilibrium) may be unfamiliar to you. To see precise definitions and examples, click here or see the menu topic.
Application
Assumptions
Equilibrium Assumption
The market is in equilibrium.
Community Use of Gasoline
The current number of vehicles is 10,000.
The average gas mileage per vehicle is 20 mpg.
The average miles each car is driven annually is 12,500 per vehicle.
Currently, a 10% increase in the price of gasoline (or oil*) produces a 2% decrease in demand.
The demand equation is linear.
Relationships Between Oil And Gasoline
One barrel of oil yields 20 gallons of gasoline.
The price of 1 gallon of gasoline is 1/20 the price of a barrel of oil.
The markup on gasoline is 50%.
* Note from the assumptions regarding the relationship between oil and gasoline that the 10% increase in price of gasoline and 2% decrease in its demand will have the same effect on price and demand for oil.
Questions
Follow the steps below to determine the price and quantity of oil supply and demand. Round answers to two decimal places.
1) How many gallons of gasoline are used by the community per day (round to the nearest gallon)?
2) How many barrels of oil are required to produce that much gasoline (round to the nearest barrel)?
3) What is the price of a barrel of oil? Use the supply function and your answer to question #2 to answer this.
4) In the three steps below, determine the equation which gives the demand for oil.
a) We will first determine points (q,p) relating price p per barrel and quantity q demanded. The first point is the current demand and price for oil as determined in this set of questions. For the second point, use the appropriate assumption to find the demand and price if the price increases 10%.
b) Use these two points to write a linear demand function which expresses selling price of oil as a function of the number of barrels.
5) Graph the supply and demand curves on the same coordinate system. Label the equilibrium point.
6) Use the appropriate assumption to determine the current selling price of gasoline? What is the total daily expenditure for gasoline?
Reflection
Many factors in addition to price might influence supply and demand. These factors will lead to a shift in the supply or demand curve.
1) Suppose that the community changes to more fuel efficient vehicles and that the average fuel efficiency rises to 25 miles per gallon. How would that change your answers?
2) Suppose that improved drilling methods cause the fixed costs of oil production to decrease from $600 to $550. How would that change your answers.
