Gm 545

Business Economics GM545

Spring 2013

Exercise 1: Everyone’s Gasoline Problem

A common application of supply and demand is witnessed through the price of gasoline. Gas prices have a relationship such that as supply increases and demand decreases, price decreases and the converse.

Gas prices continually fluctuate based on some market factors such as price per barrel of oil, economic uncertainty, and demand for oil. Some additional factors are market speculation and forecasts as well as intermediaries. It is also important to consider environmental factors such as natural disasters that may cause indirect effects on gas prices. Further, government has a large impact on the price of gas. These would include taxes and regulations imposed by our Federal, State, and Local government. These effects will have varying effects per region as we are very familiar with. For example, the price of gas in my hometown is $3.17 per gallon, while the price is $3.26 in my current area. A final fluctuation determinant that I will identify is that of the changing seasons. As we all know, gas prices change according to the time of year. For example, we all can now expect that gas prices will have an increase (sometimes drastic) in price as the fourth of July weekend approaches.

With gas prices, we experience inelastic demand. Elasticity is the measure of the responsiveness of one variable to changes in another (Stone 2008). With the case of inelastic demand, products/services do not experience much change as prices fluctuate. This is witnessed with items of necessity such as food, electricity, and gasoline. This inelastic demand for gas causes consumer to absorb price increases that are the effect of taxes.

It is important to identify that gas stations exist in a perfectly competitive market. This is a market in which the competition is all very similar and the price is generally the same in the entire market. This occurs as there is not much product...