Bus599 Week 5

Markets

To prevent gasoline prices from having devastating effects on the economy it has been proposed that all gasoline prices in the United States be fixed at the average price for the last two years. For simplicity it will be assumed that this price is $2.50 per gallon. When equilibrium prices are under $2.50 per gallon the excess payments will be kept in a government fund. When retail prices exceed $2.50 per gallon money from this fund will be distributed to pay the difference.

Do you think that this plan would help the economy? No this plan would not help the economy. According to Brownfield (2007), equilibrium price is "the price at which the quantity of a good demanded in a given time period equals the quantity supplied" (p. 382) presently the equilibrium price is about 3.50 a gallon. In addition, "whenever the market price is set above or below the equilibrium price, either a market surplus or a market shortage will emerge" (p. 386) the government setting the market price to 2.50 a gallon, below the equilibrium price they are going to create a market shortage of gasoline. The three predictable effects of price ceiling, quantity demanded increases, quantity supplies decreases, and a market shortage occurs (Brownfield, 2007).

What affect would the plan have on the supply and demand curves? Although the idea has good intentions, we all know where good intentions get us. The law of demand states "the quantity of a good demanded in a given time period increases as its price falls, ceteris paribus" (Brownfield, 2007, p. 374) and setting a fixed price of 2.50 is dropping the price by at least a dollar. According to the law of demand, the quantity of gasoline demanded is going to shift (increase). With an increase in demand comes a decrease in supplied. The market is going to demand more than there are resources.

Would gas stations and oil companies be able to stay in business? It is not likely that we will ever see gasoline prices below 2.50 so...