Question

During the past winter, average national weather trends were mild with above normal temperatures allowing for more travel and demand for automotive fuel. Oil production increased due to demand world wide. Anticipating a strong demand for fuel during the summer, oil producers increased production to maximum levels storing the surplus. Due to the coronavirus, demand for gas has dropped to only ten percent of normal summer demand, causing oil producers to pay storage brokers to take their product causing a negative profit for product. What is the impact on the equilibrium price of gas due to the pandemic?

Answer 1

The Oil Markets are seeing what is known as a demand shock. A demand shock takes place, when the aggregate demand for a product in the market sees a rapid decline. Due to the Corona Virus Pandemic, airlines as well as domestic travel is worst hit. With economies extending lock downs, the end result is that the prices of oil have fallen and so has the demand for the same.

The producers are making significant losses on the inventory which they have produced and the overall labour force in the industry may face unemployment as companies fire people to remain productive. We can illustrate the same using the following graph: -

Here we see that the Initial Demand has gone down to decreased demand and the price levels are falling in the economy. This shift is independent of the prices and the decline pushes the prices instead.

The quantity demanded has also gone down from Q2 to Q1 and the price has decreased from P1 to P2. The supply has also shrunk, and can be explained by the slope of the supply curve from Q2 to Q1 respectively.

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