Question

In 2018, a cold front in Barbados increased both the demand for water heaters and gasolines. The usage of gasoline was 581 tonnes, an increase from 499 tonnes in the previous year. The Petroleum Company of Barbados advised Government officials that demand could outweigh supply and asked companies to increase the supply. They also asked major gasoline users, such as power plants, to reduce demand.

i. Illustrate the effect of the cold front on the demand for gasoline using a demand curve diagram over the two years. [5 marks]

ii. Assuming the Petroleum Company of Barbados did not issue a directive for an increase in supply and a decrease in demand, explain the problem that would exist in the economy and how would this be corrected over time. [3 marks]

iii. Illustrate the effect of major gasoline suppliers increasing supply as well as users reducing their demand. [5 marks]

PLEASE USE MICROSOFT WORD FOR THE GRAPH ILLUSTRATIONS INSTEAD OF PAPER

Answer 1

i. Due to cold front , the demand for gasoline increases to 581 tonnes from 499 tonnes in previous year thus creating an initial shortage at current price level. This is shown below in diagram as outward shift of demand curve from D1 (2017) to D2 (2018). Demand exceeds supply at initial price level. Here supply is fixed and is shown as vertical line.

ii. In the figure above if petroleum company does not issue directive for increase in gasoline supply and decrease in demand then over time suppliers will let the shortage situation to continue which will make prices to spiral upwards and final equilibrium will be obtained at very high prices such as point B. This is because demand for gasoline is price inelastic and higher prices will hurt budget of households.

iii. If the directives by the petroleum company are followed then suppliers have to fulfill the demand for gasoline by increasing supply. So supply curve shifts rightwards to S2 . Further to ensure equilibrium, government will raise taxes on gasoline which will reduce demand for gasoline. This is shown in figure below. -

Initially demand curve shifts rightwards.Supply is increased to Q*. Further taxes of T is imposed to ensure demand reduces and meets new supply curve at point F. At this point final equilibrium is reached.