Everyone’s Gasoline Problem

Question 1: Everyone’s Gasoline Problem. We are all familiar with fluctuating prices of gasoline at the pump. Why does this happen? Research the recent history of gasoline prices in your area, and attempt to relate any fluctuations you observe to documented supply and demand factors, as outlined in our book. Be sure to cite any references used.

Answer: Gasoline prices in Orange County have risen from $1.94 to $2.34 over the last 12 months with a series of price fluctuations in between. Prices fluctuate for a number of economic reasons. One such reason is supply and demand. We have seen gas prices rise after 9/11 and more importantly after the start of the war with Iraq (See Figure 1).

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So, why does supply and demand lead to fluctuation of gasoline prices? It is quite simple if we understand the laws of supply and demand. In order to understand this we must first define both supply and demand and how they work. Supply is defined as a schedule or curve showing the amounts of a product that producers are willing and able to make available for sale at each of a series of possible prices during a specific period. The law of supply states that as prices rises, the quantity supplied rises and vice versa. Demand is defined as a schedule or curve that shows the various amounts of a product that consumers are willing and able to purchase at each of a series of possible prices during a specified period of time. The law of demand states that all else equal, as price falls, the quantity demanded rises, and vice versa.

The uncertainty of the supply for crude oil due to the war with Iraq is the primary factor for the fluctuation in gasoline prices. From pure economic definition of the law of supply and demand and their tendency to gravitate toward an equilibrium price, we can see that due to the lack of supply and high demand, prices would have to increase which would then bring demand down. In reality though in the case of gasoline, we have not really seen a decrease in demand since all else is not held equal in reality. People are still lining up at the pumps and sales of gas guzzling SUV’s have not diminished either. This may be due to the lack of public transportation in California which has led owning a vehicle to be a necessity rather than a luxury.

Web-Based Question 3-17: The U.S. Department of Agriculture, www.usda.gov/nass publishes charts on the prices of farm products. Go to the USDA home page and select Charts and Maps and then Agricultural Prices. Choose three farm products of your choice and determine whether their prices (as measured by “prices received by farmers”) have generally increased, decreased, or stayed the same over the past 3 years. In which case, if any, do you think the supply has increased more rapidly than demand? In which of the three cases, if any, do you think that the demand has increased more rapidly than supply? Explain your reasoning.

Answer: The three farm products chosen are as follows:

1. Cattle- The U.S Department of Agriculture breaks Cattle up into four categories namely, Calves, Steer/Heifer, All Beef Cattle and Cows. In looking at the graphical data and trends it seems that over the past 3 years the price of Cattle as received by farmers has remained pretty steady with a slight increase in 2004 (See Figure 2a). The increase can be associated to diminishing supply due to diseases such as Mad Cow Disease and increases in demand due to diets like the Atkins Diet. I think that in the case of cattle over the last 3 years supply and demand have been in equilibrium as there does not seem to be a dramatic increase or decrease in prices received by farmers.

2. Milk- According to the data from the U.S. Department for Agriculture, milk has seen a series of fluctuations in prices received by farmers over the last 3 years, with a steady rise since June of 2003 (See Figure 2b). In this case, I think one can ascertain that demand increased more rapidly than supply which led to the increase in price. The higher price would deter people to buy less milk and encourage people to buy substitutes.

3. Cotton- Analyzing the data from the U.S. Department for Agriculture, cotton has seen a steady rise in the prices received by farmers since May 2002. I think that demand increased faster than supply. As in milk above, this would lead to higher prices and thus gravitate towards establishing equilibrium price and quantity for supply and demand.

Web Based Question 20-17. The price of gold—today , yesterday and throughout the year. Visit www.goldprices.com to find the very latest price of gold. Compare that price to the price at the beginning of the day. What was the highest price during the last 12 months? The lowest price? Assume the price fluctuations observed resulted exclusively from changes in demand. Would the observed price changes have been greater or less if the gold supply had been elastic rather than inelastic? Explain.

Answer: The price of gold as of end of trading on July 23, 2004 was $389.90 per ounce (See Figure 3a). The price at the beginning of the trading day was $394.40. The difference between the price at the start of the day and end of the day shows the change in price. During the trading period for July 23, 2004 there was a $4.50 ($394.40-$389.90) drop in the price of gold. According to data from www.Kitco.com the highest price of gold over the last 12 months was $427.25 on April 1, 2004 and the lowest price was $347.50 on August 4, 2003 (See Figure 3b).

Price elasticity of supply is defined as the responsiveness (or sensitivity) of producers to respond to a price change. The amount of price elasticity of supply depends on how easily and quickly producers can shift their resources between alternate uses. In the case of gold we can see that gold is highly inelastic, as producers cannot react quickly to changes in demand due to the complicated mining processes and costs involved. This is primarily the reason gold mining companies cannot be shut down easily. In this situation price decreases do not produce a significant decrease in supply. For gold due to it inelasticity, relatively small changes in demand produce relatively large changes in price.

If the supply of gold were elastic then we would observe fewer changes in observed prices. Producers of gold would be able to respond quickly to the changes in demand, as they would be able to shift their resources quickly and put their resources to substitute products if required. This would lead to less fluctuation in the prices of gold.

Web based Question 23-10. Entry and exit of firms—where have they occurred? Go to the Census Bureau website at www.census.gov and select Economic Census, then Manufacturing, and then Comparative Statistics. Identify three manufacturing industries that have experienced large percentage increases in the number of firms between 1997 and 2002. Identify three manufacturing industries that have experienced large percent decreases. What single factor is the most likely cause of entry and exit differences between the two groups? Explain.

Answer: Analysis of the data provided by the census website for manufacturing industries shows that 3 industries with the most percentage increase of establishments were: 1. Primary Metal Mfg. (17.652%); 2.Beverage and Tobacco Product Mfg. (9.9%); 3.Petroleum and Coal Product Mfg. The three manufacturing industries that have experienced a large percent of decrease in the number of firms are: 1. Apparel Manufacturing (-26.329%); 2.Leather and Allied Product Manufacturing (-18.592%); 3.Textile Mills (-16.127%). (See Table 1)

I think that the single factor that is the most likely cause of entry and exit differences between each group is profitability (the bottom line). For each of the industries that have seen an increase in firms, they are all highly profitable industries. Each industry is supplying their products for increase in demand in their respective industries. These industries are able to maximize their profits if their price is equal to or greater than their average variable costs.

For the industries that decreased in manufacturing firms, profitability was diminished due to global competition. All the industries that had a decrease in firms are in the retail industry. Although demand has not decreased for the products provided by the manufacturers, the cost of doing business is high compared to like manufacturers globally. The major source of cost differentiation in these industries is lower labor costs for the global competitors. Designers could get clothing manufactured cheaper in other countries than they could in the U.S. They could not attain the same productive efficiencies as their global competitors and thus had to shut down.

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