Question

The recent announcement by Saudi Arabia to raise production and offer its crude at deep discounts comes on top of the global impact from the Coronavirus. The combination has seen crude oil price fall 50% since the beginning of the year with great uncertainty for future price movements. Use supply and demand diagram to illustrate:

1. The impact of lower crude oil prices on the price of petrol.
2. The price of petrol will affect price and quantity of used gas-guzzling cars.
3. How does the change in petrol price affect the price and the quantity of used hybrid cars?

Answer 1

In following graphs, D0 & S0 are initial demand and supply curves, intersecting at equilibrium point A with initial equilibrium price P0 and initial equilibrium quantity Q0.

(i)

Lower price of crude oil, an input to petro production, will reduce its production cost, so firms increase production. Supply increases, shifting supply curve to right, decreasing price and increasing quantity.

In following graph, S0 shifts right to S1, intersecting D0 at point B with lower price P1 and higher quantity Q1.

(ii)

Lower price of petrol, a complement to gas guzzling cars, will increase their demand. This shifts demand curve to right, increasing price and increasing quantity.

In following graph, D0 shifts right to D1, intersecting S0 at point B with higher price P1 and higher quantity Q1.

(iii)

Increase in price of gas-guzzling cars, a substitute to used hybrid cars, will increase their demand. This shifts demand curve to right, increasing price and increasing quantity.

In following graph, D0 shifts right to D1, intersecting S0 at point B with higher price P1 and higher quantity Q1.