Question

Let the market for gasoline be in equilibrium. The price of cars see a decrease and at the same time there is a new technology identified known as fracking which allows us to extract crude oil easier than before. Draw a neatly labelled equilibrium diagram and neatly indicate the shifts of the demand and supply curve. What happens to equilibrium price and quantity of gasoline?

Answer 1

Answer

The gasoline market is in equilibrium. Now, if the price of cars decreases, it will increase the quantity demanded for cars. The increase in the quantity demanded for cars will increase the demand for gasoline. As a result, the demand curve for gasoline will shift rightward. Now, at the same time, the invention of new technology helps to extract crude oil easier than before. This will increase the supply of crude oil and hence gasoline.So, the supply curve of gasoline will shift rightward. In this scenario, the equilibrium quantity of gasoline will rise in the market but the change in the equilibrium price of gasoline will depend on the relative change in supply of and demand for gasoline. We will use three figures here to see the change in gasoline market.

Case 1: The increase in the demand for gasoline is exactly equal to the increase in the supply of gasoline

Result: Equilibrium quantity of gasoline will rise; Equilibrium price of gasoline will riemain same.

In the above figure, the quantity of gasoline is measured on the horizontal axis and the price of gasoline is measured on the vertical axis. The curve 'D1' is the initial demand curve for gasoline and the curve 'S1' is the initial supply curve of gasoline. The point 'e1' shows the market equilibrium point where, the equilibrium market price is 'P1' and the equilibrium market quantity is 'Q1'. Now, the demand curve for gasoline shifts rightward to 'D2' and the supply curve of gasoline shifts rightward to 'S2'. From the figure, we see that the both the curves shift rightward at the same proportion. After the shift of the curves, the new market equilibrium point attains the point 'e2', at which the equilibrium price remains same as before, i.e., 'P1' and the equilibrium quantity rises to 'Q2'.

So, here we see that the equilibrium quantity of gasoline rises and the equilibrium price of gasoline remains constant.

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Case 2: The increase in the demand for gasoline is larger than the increase in the supply of gasoline

Result: Equilibrium quantity of gasoline will rise; Equilibrium price of gasoline will rise.

Like the first figure, in the above figure also, the quantity of gasoline is measured on the horizontal axis and the price of gasoline is measured on the vertical axis. The curve 'D1' is the initial demand curve for gasoline and the curve 'S1' is the initial supply curve of gasoline. The point 'e1' shows the market equilibrium point where, the equilibrium market price is 'P1' and the equilibrium market quantity is 'Q1'. Now, the demand curve for gasoline shifts rightward to 'D2' and the supply curve of gasoline shifts rightward to 'S2'. From the figure, we see that the magnitude of the shift of the demand curve is greater than the magnitude of the shift of the supply curve. As a result, the equilibrium price of gasoline rises to 'P2' with the rise in the equilibrium quantity of gasoline to 'Q2'. The new market equilibrium point is shown by point 'e2'.

So, here we see that the equilibrium market price of gasoline rises with the rise in the equilibrium quantity of gasoline.

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Case 3: The increase in the supply of gasoline is larger than the increase in the demand for gasoline

Result: Equilibrium quantity of gasoline will rise; Equilibrium price of gasoline will fall.

In the above figure, the curve 'D1' is the initial demand curve for gasoline and the curve 'S1' is the initial supply curve of gasoline. The point 'e1' shows the market equilibrium point where, the equilibrium market price is 'P1' and the equilibrium market quantity is 'Q1'. Now, the demand curve for gasoline shifts rightward to 'D2' and the supply curve of gasoline shifts rightward to 'S2'. From the figure, we see that the magnitude of the shift of the supply curve is greater than the magnitude of the shift of the demand curve. As a result, the equilibrium price of gasoline falls to 'P2' with the rise in the equilibrium quantity of gasoline to 'Q2'. The new market equilibrium point is shown by point 'e2'.

So, here we see that the equilibrium market price of gasoline decreases with the rise in the equilibrium market quantity of gasoline.

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