Question

By using 2-dimension graphs for PRICE and QUANTITY, demonstrate the effect that each of the following will have on the demand for gasoline in a competitive market? State what happens to demand. Explain your reasoning in each case and relate it to a demand determinant.

(a) an increase in the number of cars(25 points)

(b) the economy moves into a recession (25 points)

(c)   an increase in the price of car insurance, taxes, maintenance(25 points)

(d) consumer expectations of substantial price increases in gasoline(25 points)

Answer 1

a. An increase in the number of cars will increase, people will demand for higher amount of gasoline, as a result of which demand for gasoline will increase, and demand curve for gasoline shifts rightward from D1 to D2 and as the economy moves from point A to point B, the price of gasoline will increase and the quantity of gasoline will also increase. Here cars and gasoline are perfect complements and the determinants for this rightward shift of demand curve for gasoline is the increase in the number of complementary goods i.e increase in the number of cars.

b. As the economy moves into a recession, hence people will buy less cars as due to recession, income level of consumers fall. And as number of cars fall, its demand for complement i.e amount of gasoline will fall and the demand curve for gasoline will shift leftward from D1 to D2 and the price of gasoline falls from P1 to P2 and the quantity of gasoline will fall from Q1 to Q2. Here shift of the demand curve is due to the determinants of economic contraction.

c. An increase in the price of car insurance, taxes, maintenance will lead to a decline in the demand for cars and as car and gasoline are perfect complements, lower demand for cars will result in lower demand for gasoline and hence the demand curve for gasoline will shift leftward from D1 to D2. Here the leftward shift of the demand curve is due to the decline in the demand for its complements i.e cars. Hence price of gasoline will fall from P1 to P2 and quantity of gasoline falls from Q1 to Q2.

d. Consumer expectations of substantial price increases in gasoline, will lead to higher demand for gasoline in present period as consumer will expect higher price of gasoline in the future. As the present demand for gasoline rises, the demand curve for gasoline will shift rightward and the price of gasoline will increase from P1 to P2 and the quantity of gasoline will increase from Q1 to Q2. Here the rightward shift of the demand for gasoline is due to the rise in the expected price of gasoline.