Question

Supply and Demand: the Revenge of the Exogenous Shock. In this problem, we consider many changes (exogenous shocks) that can affect the market for oil. Predict how each of the following events will affect the equilibrium price and quantity in the market for oil.

• In each case, sketch a supply and demand diagram (model) to support your answer, using the 4-step process we derived in class and perform equilibrium analysis (what happens to Q and P in equilibrium). You must create an original figure. Depict demand for oil as price inelastic.
• Solve for all eight of these shocks using the 4-step process. State what type of shock each represents.
• Be clear and use words in captions to describe your eight figures and your analysis (what's going on in the market, Bloomberg style).

a. Cars are becoming more fuel efficient, and therefore get more miles to the gallon.

b. The winter is exceptionally cold this year.

c. A major discovery of new oil is made off the coast of Norway.

d. The economies of some major oil-using nations, like Japan, slow down.

e. A war in the Middle East disrupts oil-pumping schedules.

f. Landlords install additional insulation in buildings.

g. The price of solar energy falls dramatically.

h. Chemical companies invent a new, popular kind of plastic made from oil.

Answer 1

	Diagram	Implication	Step 1	Step 2	Step3	Step 4
Initially	D is the price inelastic demand curve for oil and S is the supply curve. Initially oil market is at equilibrium at E. Equilibrium price is OP and Equilibrium Quantity is OQ.
a. Cars are becoming more fuel efficient, and therefore get more miles to the gallon.		More fuel efficiency means lesser demand for fuel as cars can run more miles with the same amount of fuel	demand decreases and demand curve shifts to the left to D1	Price falls to OJ	Supply contracts and there is movement downwards from E to e	lesser quantity is demanded and supplied - OL
b. The winter is exceptionally cold this year.		Tapping solar energy is difficult and more fossil fuel is needed	Demand increases and demand curve shifts to D0 to the right	Price rises to OT	There is extention of supply. A movement from E to e along the supply curve	higher quantity i.e, OR is demanded and supplied
c. A major discovery of new oil is made off the coast of Norway.		more can be supplied to the market	Supply increases and supply curve shifts to S1	Price falls to OB	There is extension of demand	more quantity is demanded and supplied-OA
d. The economies of some major oil-using nations, like Japan, slow down.		slowdown in the economies will lead to decline in demand from their side	demand will decrease and new demand curve will be leftwards at D	price will fall to OB	Contraction of supply from E to K	lesser quantity will be demanded and supplied- OZ
A war in the Middle East disrupts oil-pumping schedules.		There will be a supply shock and supply will decrease	supply curve will shift to the left to S2	price will rise to OA	demand will contract from E to L	Lower quantity will be demanded and supplied - OJ
f. Landlords install additional insulation in buildings		possible to use alternative sources of energy so demand less oil	demand decreases and so demand curve shifts to the left to DL	prices fall to OB	contraction of supply from E to K	lesser quantity is demanded and supplied - OZ
The price of solar energy falls dramatically.		solar energy is a substitute for several fossil fuel based energy sources so demand for oil will fall	demand curve will shift to the left to D'	price will fall to OG	contraction of supply from E to e	lesser qunatity is demanded and supplied - OC
h. Chemical companies invent a new, popular kind of plastic made from oil		demand for oil as a raw material will increase	demand curve will shift to the right to Do	Price will rise to OT	there will be extention of supply from E to e	more quantity will be demanded and supplied in the market --OR