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  Business  Economics  (Assignment  1)     Name  :   Harshvardhan  Vasudeva   Student  No.:   s865153   Module:   Business  Economics   Lecturer:   Mr  B.

 Harrison  BA  MA         Q1  What  does  the  passage  imply  is  the  cause  of  rising  gas  prices?  Explain  your   answer  fully  and  with  appropriate  diagrams.     The  passage  clearly  states  that  the  rise  in  gasoline  prices  began  to  gain  steam   after  political  turmoil  surged  in  the  Middle  East  in  February.  Commodity  prices   increased  at  alarming  rates  due  to  supply  disruptions.  Libya,  one  of  the  key   exporters  of  crude  oil  in  the  world,  ignited  concerns  of  lost  crude  oil  production,   which  thereby  led  to  soaring  prices  of  crude  oil  in  February  2011.   Thus,  the  main  cause  of  rising  gas  prices  in  USA  in  one  word  was  –  Libya.   Anti-­‐government  unrest  continued  in  Middle  Eastern  countries  such  as  Bahrain,   Libya  &  Egypt.  But,  it  was  unrest  caused  in  Libya  that  was  felt  the  most  with   respect  to  gasoline  prices  in  the  USA.  Most  of  the  Libyan  light  sweet  crude  gets   exported  to  European  countries  such  as  Italy,  Germany,  France  and  Spain  and   almost  40  percent  of  that  is  exported  to  the  USA.  Thus,  any  disruptions  felt  in   Libya  affects  Europe  that  in  turn  affects  the  USA.   But  these  disruptions  could  be  worsened  had  there  been  unrest  in  Saudi  Arabia,   which  accounts  for  9  percent  of  the  world’s  supply  and  11  percent  of  the  world’s   supply  of  crude  oil.               P   S0         S1       P1     P0         D       Q   Q1    Q0     Graph  1       In  this  case,  changes  in  quantity  demanded  are  caused  due  to  changes  in  price.   On  the  other  hand,  changes  in  supply  curve  (supply  curve  shifts)  are  caused  due   to  factors  such  as  costs,  technology,  number  of  producers,  time  etc.     This  can  be  clearly  seen  in  Graph  1.     The  current  turmoil  in  the  Middle  East,  especially  Libya,  caused  a  reduction  in   supply  and  thus  an  increase  in  price  since  there  was  less  supplied  and  people   had  to  pay  more  for  the  same  quantity.    This  led  to  a  decrease  in  the  quantity    

  Formula  for  Price  Elasticity  of  Demand  (Ped):   Ped  =  ∆Q      x        P                                Q                ∆P   Demand  is  said  to  be  elastic  when  the  elasticity  is  greater  than  1.   demanded  in  the  USA  since  the  price  of  gasoline  probably  went  above  their   expectations  and  budgets.  (Ped  >  1)   Demand  is  inelastic  when  the  elasticity  is  less  than  1.  It  is  denoted  by  ∆  (delta).  (Ped  <  1)   Lastly.   • Price  Elasticity  of  Demand:  The  price  elasticity  of  demand  measures  how   much  the  quantity  demanded  responds  to  a  change  in  price.  if  the  quantity  moves  in  the  same  proportion  as  the  price.  This  means  that  the   quantity  changes  proportionately  less  than  price.  This  means  that   the  quantity  changes  proportionately  more  than  price.  Thus.  we  will  be  using  the  Price  Elasticity  of  Demand.                             Source  -­‐  Energy  Information  Administration       Q2  What  is  meant  by  elasticity  of  demand  and  what  does  the  passage  imply   about  the  price  elasticity  of  demand  for  gas?     Elasticity  of  demand  measures  how  much  the  quantity  demanded  responds  to  a   change  in  one  of  its  determinants.     With  respect  to  this  case.  ∆Q  refers  to   changes  in  quantity  demanded  whereas  ∆P  refers  to  changes  in  price.  (Ped  =  1)       For  example:     Price  (€)   Quantity     20   2000     16   3000         .   • Cross  Elasticity  of  Demand:  The  cross  elasticity  of  demand  measures  how   the  quantity  demanded  of  one  good  changes  as  the  price  of  another  good   changes.  demand  is  said   to  have  unit  elasticity.   Elasticity  of  demand  can  be  divided  into  its  further  determinants:   • Income  Elasticity  of  Demand:  The  income  elasticity  of  demand  measures   how  the  quantity  demanded  changes  as  consumer  income  changes.

 using  the  formula  for  Ped.  an  inverse  relation  is  seen  between  the  price  of   one  good  and  the  demand  of  the  other.   The  decline  may  also  be  caused  by  Americans’  switch  to  more  fuel-­‐efficient  cars   since  2008.6  percent  in  the  week  ending  April  1  for  the  fifth  consecutive  year.  the  consumption  of  gasoline  has  been   decreasing  year  after  year.   P0  (20)  -­‐>  P1  (16).  the  demand  is  elastic.  the  supply  of   gasoline  reduces  (due  to  political  turmoil  etc.  hence  the  negative  is   ignored).  This  decline  means  that  either  people  have  reduced   driving  their  cars  or  they  have  shifted  towards  more  fuel-­‐efficient  cars.   Ped  =  1000  x  20    =  -­‐2.  it  can  be  said  that  with  an  increase  in  the  price  of   gasoline  a  decrease  in  the  demand  of  normal  (non-­‐fuel  efficient)  cars  is  seen.  Also.  i.  Furthermore.  a  fall  in  the  price  of  one  good  leads  raises  the  demand  for   another  good.     The  passage  implies  that  the  demand  for  gas  is  elastic.  and  maybe  combine  their  car  trips  with  errands.   As  stated  by  the  spokesman  for  AAA  New  York.  despite  the  rising  oil  prices.  which  is  >1.  as  the  price  of  gasoline  rises  a  decrease  in  the   demand  for  normal  cars  is  seen  (Graph  2).  On  the  contrary.  Change  in  Quantity  demanded  ∆Q  =  1000       Thus.  like  recreation  and  hotel  businesses.  the  Ped  is  2.  economists  expect  Americans  to  make  fewer  non-­‐ essential  trips  by  car.  Higher  changes  in  quantity  demanded  will  be  seen  as  prices   fluctuate.  I.e.   said  that  as  per  a  MasterCard  Advisors  SpendingPulse  report.5  (we  only  take  absolute  values.     With  respect  to  normal  cars.  In  easier  words.     “People  just  don’t  have  the  elasticity  in  their  budgets”     Thus.  Economists  say  that   industries  that  indirectly  depend  on  gas.   might  feel  the  pinch  of  lower  customers  during  Memorial  Day  weekend  &  during   summer.  the  consumption  of   gasoline  fell  3.     Considering  the  latter  scenario.  Mr  Robert  Sinclair  Jr.  rising  gas  prices  will  directly  affect  the  demand  (consumption)  of  gas  by   consumers.   Yet.5                        2000  x  -­‐4     In  this  example.  and  thus.     The  above  line  is  in  context  to  the  question  why  the  consumption  of  gasoline  has   reduced  in  the  USA.).  the  economy  seems  to  be  in  better  condition  than  it  was   three  years  ago.e.         Q3  Explain  and  illustrate  with  an  appropriate  diagram  the  phrase  underlined  I   the  passage  above.     The  relationship  between  gasoline  and  normal  cars  can  be  said  as   complementary.  John  Gamel.  as  per  the  article..  This  is  assuming  that  the  supply  and   price  for  normal  cars  remains  the  same  and.  the  labour  market  has  seen  consistent   improvement.  consumption  of  gasoline  should   have  increased.  the  director  of  gasoline  research  MasterCard.  people  have  better  incomes..  This  leads  to  an  increase  in  the     .  Change  in  Price  ∆P  =  -­‐4   Q0  (2000)  -­‐>  P1  (3000).

  demand  for  fuel-­‐efficient  cars  which  causes  the  demand  curve  to  shift  upwards   (Graph  3).  Demand  reduces   from  D0  -­‐>  D1  due  to  external  reasons  such  as  switching  over  to  fuel-­‐efficient  cars   or  cut  down  in  driving.  it  is  assumed  that  the  supply  and  price  for  fuel-­‐efficient  cars   remains  the  same.  Again.                          P         Normal  Cars   S             P0     P1     D1   Q1    Q0   Graph  2     Fuel-­‐efficient  cars     D0   Q               P           P 1       P0                                                      P                   Gasoline  Prices   S   P0   P1   D1   Q       S   D0   Q0    Q1   Graph  3   D1   Q1    Q0         Graph  4   D0   Q       .   Graph  4  shows  the  demand  and  supply  position  for  gasoline.

 natural  gas  and  electricity.   the  country  will  have  to  pay  more  to  buy  oil  because  the  worth  of  the  currency  is   reduced.  This  would   reduce  liquidity  for  individuals  and  thus  reduce  their  purchasing  power.  Other   effects  could  be  that  it  could  weaken  the  currency  value  of  a  country.  The  demand  for  products  may   go  lower  which  causes  manufacturers  to  reduce  supply  (since  there  is  an   excessive  of  supply).         AS0            P           AS1     P1     P0              AD0     AD1           Q1                        Q0   Q                                        Graph  5     .  thus   reducing  the  aggregate  demand  and  eventually  the  aggregate  supply.  this  will  increase  inflation  levels  and  will  cause  the   government  and  central  bank  to  intervene  to  increase  interest  rates.    Energy  prices  rise  due  to  the   surge  in  crude  oil  (main  component  of  gasoline)  prices.   In  general.   Q4  Explain  and  illustrate  with  appropriate  diagrams  the  following  sentence:  “The   recent  surge  in  energy  prices  may  well  slow  the  pace  of  economic  recovery  in  the   next  few  quarters”     Supply  and  demand  curve  shifts  are  based  on  factors  other  than  price.  Graph  5  suggests  that  due  to  reasons  explained  above.   Some  of  the  factors  are:   • Input  Costs   • Distribution  Costs   • Technology   • Number  of  Producers   • Expectations   • Natural  Factors       Energy  includes  oil.  The  above-­‐mentioned  issues  could  adversely  hamper  the  economic   recovery  of  an  ailing  country.  Thus.   On  a  national  level.  This  could  lead  to  an  increase  in  the  rate  of  unemployment.  A  surge  in  energy  prices  has  a   damaging  chained  reaction  on  economic  growth.  the  surge  in   energy  prices  causes  a  reduction  in  the  aggregate  demand  and  aggregate  supply.  in  this  case.  production  costs  rise.  This  directly  impacts   manufacturing  industries  by  increasing  their  raw  material  cost  as  well  as   transportation  costs.  They   will  spend  a  smaller  portion  of  their  income  on  discretionary  goods.

 This  has  an  effect  on  the  consumers   who  start  cutting  down  on  purchasing  discretionary  products.   A  rise  in  gasoline  prices  affects  the  transport  and  delivery  system  which  makes   products  at  supermarkets  more  expensive.  for   example  petroleum  and  natural  gas  (with  respect  to  heaters).   Formula:     CPed  =  ∆QA        x  PB          .  the  hike  in  gasoline  prices  was  directly  related  to  rising   crude  oil  prices  due  to  the  political  turmoil  in  the  Middle  East  that  caused  supply   disruptions.     .  Others   might  stay  at  cheaper  hotels  or  dine  at  cheaper  restaurants     Although  economists  are  still  trying  to  determine  what  the  long-­‐term  impact  of   such  behaviour  will  be.   Q5  With  reference  to  gas  and  hotel  prices.  the  CPed  is   positive.  Thus  if  the  price  of   petroleum  goes  up  the  demand  for  natural  gas  goes  up.     Memorial  Day  is  the  last  Monday  in  May.  could  feel  the  pinch  over  Memorial   Day  weekend  and  during  the  summer”     As  mentioned  earlier.  hence   people  have  to  travel  by  vehicle  in  order  to  reach  their  destinations.  like  recreation  and  hotel  businesses.  It  is  a  holiday  in  the  USA  and  makes  for  a  long   weekend  for  people  to  have  a  short  vacation  or  to  meet  family  and/or  friends.  Where  ∆  denotes  “percentage  change”        QA                  ∆PB     The  result  of  the  CPed  depends  on  whether  the  two  goods  are  substitutes  or   complements.  higher  gasoline  prices  will  negatively  impact  recreation   and  hotel  businesses.  Some  of  the   effects  higher  gasoline  prices  have  on  people  on  Memorial  Day  and  summer  are:   • The  economy  is  better  than  it  was  3  years  ago.  Substitutes  are  goods  that  can  be  used  in  place  of  one  another.  explain  fully  and  illustrate  the   sentence:  “Economists  are  also  saying  that  industries  that  depend  on  travel   revenue.   • Those  going  on  vacation  via  air  or  car  will  not  spend  as  much.  job  security  is  increasing   but  stagnant  wages  combined  with  increasing  gasoline  prices  will  keep   people  closer  to  home.     It  is  calculated  by  finding  out  the  percentage  change  in  quantity  demanded  of   good  “A”  and  dividing  it  by  the  percentage  change  in  the  price  of  the  good  “B”.  on  which  those  who  died  during   military  service  are  remembered.  Since  the  price  of   petroleum  and  demand  for  natural  gas  move  in  the  same  direction.   Usually  most  public  transport  does  not  function  smoothly  on  this  day.         Q6  What  are  the  main  determinants  of  cross  elasticity  of  demand  and  for  what   practical  purposes  might  the  concept  be  useful?     Cross-­‐price  elasticity  of  demand  is  the  measurement  of  how  the  quantity   demanded  by  one  good  changes  as  the  price  of  another  good  changes.

  CPed  is  very  important  for  firms  as  this  can  help  them  divide  their  products   and/or  services  into  categories  of  either  substitutes  or  complements  and  hence   devise  pricing  strategies.house.com/Business/gas-­‐prices-­‐hit-­‐384-­‐memorial-­‐day-­‐weekend-­‐ approaches/story?id=13399636#.  increase  their  total  revenue  and  hence  increase   profitability.net/economics/revision-­‐notes/as-­‐markets-­‐crossprice-­‐elasticity-­‐ of-­‐demand.   Complements.TuvdZ2BhFss     http://articles.  are  goods  that  are  used  together  and  a   fall  in  the  price  of  one  good  leads  raises  the  demand  for  another  good.go.com/Business/highest-­‐gas-­‐prices-­‐february-­‐1990-­‐attributed-­‐ libya-­‐turmoil/story?id=12973910#.  once  consumers  are   habituated  to  a  product.   Post  advertising  and  marketing  for  substitute  products.html     Economics  (2nd  edition)  Mankiw    Taylor             .com/2011/04/12/business/12fuel.gov/News/DocumentSingle.  as  discussed  earlier  in  Q3.go.TukkI2BhFss     http://www.  Thus.html     http://abcnews.  This  makes  demand  less  sensitive  to  price.  CPed  of  demand  against  competitor’s  products  will   decrease.         References:     http://naturalresources.nytimes.  the  CPed  for  these  goods  is  negative.  Thus  firms  may  be  able  to   charge  a  higher  price.philly.  For   example:  petrol  and  cars.com/2011-­‐05-­‐25/business/29582085_1_gas-­‐prices-­‐travel-­‐ plans-­‐holiday-­‐travelers     http://tutor2u.  If  the  price  of  petrol  goes  up  the  demand  for  cars  goes   lower  (people  prefer  to  use  other  modes  of  transport  for  example  public   transport).aspx?DocumentID=2 26067     http://abcnews.