Question

If the demand for gasoline is flexible ,discuss what you would expect to be the shape of aggregate demand for gasoline and how people would react to low, moderate and high level of prices of gasoline and how they would change their gas consumption based on these prices.

Answer 1

The AD curve slopes downwards which means increase in the price level leads to lower spending . The different components of AD are affected by changes in the price level .So the components are AD=C+I+G+(X-M) where C is consumption,I is investment spending ,G is government spending and X-M is spending on net exports ie X exports minus M imports.High gas prices mean people will spend more on gas and thus will have less to spend on other goods and services.So discretionary spending will decrease.Gas consumption will decrease.and transportation cost will increase.Low gas prices will lead to increase in the demand and spending will increase . Consumption will increase. So there is a correlation between gas prices and consumer confidence as well as in spending .Moderate increase in gas prices will not affect consumption much as prices of essential things will not increase much.Spending will not decrease much .