Application Of Law Of Demand And Supply: Impact On Fuel And Car Markets And Inflation-Essay.

The impact of supply disruption on fuel market

The report demonstrates the application of the concept of law of demand and supply to address the given questions. All the questions have been explained using the economic concepts depicted by the presentation of diagrams illustrating different scenarios. The relationship between inflation and unemployment has been explained specifically in relation to the developing economies. In addition to the above, the impact of different events on the aggregate demand and aggregate supply is explained by plotting in appropriate AD-AS diagram. Impact of all the events on the real GDP and equilibrium level is explained diagrammatically.

The disruption in the supply of fuel in the country A due to the breaking out of war implies that the supply of fuel has decreased. A decrease in the supply would cause an upward or leftward shift in the supply curve. Demand remaining unchanged, it is observed that there arises the situation of excess demand and this creating demand surplus and this surplus would increase the price to a new equilibrium level. Therefore, the equilibrium demand of fuel would decrease and equilibrium price would increase.

Fuel market

The above graph depicts the fuel market, where initial equilibrium is at E₀ where Q_o and P₀ is the equilibrium quantity and equilibrium price of fuel. Decrease in supply due to disruption shifts the supply curve from S₀ to S₁ and the new equilibrium is determined at E₁. At this equilibrium level, new equilibrium price is P₁ and Q₁ respectively, indicating higher equilibrium price and lower equilibrium quantity. Therefore, decrease in supply causes the equilibrium price to increase the equilibrium quantity to decrease as shown in the above graph.

From above discussion, it is clear that the disruption in the supply of fuel due to breaking out of war has caused price of fuel to increase and this resulted in decrease in the fuel demand. Now, it is required to see the impact of fuel supply disruption on the supply and demand for cars. Since, fuel and car are the complementary commodity, there exist a negative or inverse relationship between the price of one commodity and demand of another (Mazurek et al. 2019). Hence, an increase in price of fuel due to decrease is supply would cause the demand for cars to decline. That is, when the supply of fuel decrease, there would be automatic decline in the demand for cars because one commodity complement the other commodity. Supply of cars would not change and at the prevailing equilibrium price, there would be excess supply of cars and thereby creating a surplus and the surplus would drive down the price to a lower level of equilibrium (Bhandari 2018).

The impact of supply disruption on car market

Fuel market

Fuel market scenario is explained in the first section and it is required to explain the impact on the car market.

Car market

The above graph shows the car market scenario where E₀ is the initial equilibrium point resulting from the intersection of the initial demand D₀ and supply curve S₀. The equilibrium price and quantity of cars demanded and supplied below the disruption in the fuel supply was P₀ and Q₀. Now, due do fall in fuel supply, demand for car also decreases and this causes the demand curve to shift downward or leftward to D₁. With the supply of cars remaining unchanged and a decline in the demand for cars creates a situation of surplus and the surplus drive down the price and quantity to a new low equilibrium level of P₁ and Q₁ respectively. The new equilibrium level is determined at E₁. Therefore, it is inferred that due to car, the quantity and price of cars would decline.

If the demand for car is elastic implies that even small increase in price would impact the demand significantly. Imposition of tax by the government in country A would increase the overall price of cars and this would trigger a significant decline in the demand, as the demand for car is elastic. And typically, the tax burden falls on both the suppliers and consumers. However, it is the demand elasticity that determines which group would bear the most burden of tax and the more burden is borne by the inelastic side of the market. Since, demand is elastic indicating that consumers would lower their purchase of car significantly due to increase in price resulting from imposition of taxation (Fukase and Martin 2020). Compared to this, suppliers’ side is relatively inelastic and from the concept of elasticity, it is very well understood that more of the cost due to the taxation would be borne by the producers or suppliers.

The above diagram shows E₀ as the equilibrium where the relatively inelastic supply curve and elastic demand curve intersect giving equilibrium quantity at Q₀ and equilibrium price at P₀. By the imposition of tax, a wedge is created by the government between the price being by the consumers (Pt) and the price received by sellers (P₁). In other words, it can be said that the total price being paid by the consumers is divided between the government and suppliers or the producers. Tax rate is indicated by the difference between P_t and P₁ and the new price for cars prevailing in the market after the tax is imposed is Pt. At new market price Pt, sellers are receiving P₁ and (Pt-P₁) is being paid to the government as tax. An increase in tax can be viewed as increase in the cost of production by the producers and at higher production cost, sellers would be less willing to supply their products (Dean et al. 2020). Following from this logic, the supply of car would decrease causing leftward shift in the supply curve and the new supply curve S_1. Sellers under such scenario experiences a disproportion impact of the tax burden and the shaded area represents the tax revenue. The above graph well depicts the impact of tax burden on consumers as well as sellers or producers. Therefore, it is evident from the above graph that more of the tax burden is borne by the suppliers than consumers because the demand elasticity for cars is elastic.

Impact of taxation on car market

The relationship of unemployment and inflation is considered to be the analysis that has gained considerable importance in literature. An inverse relationship between the unemployment rate and rate of inflation is shown by the Philips curve and is compatible with the approach of Keynesian. A vital source of the economic performance of any economy is the unemployment rate and it has been found by the economist that the inflation rate tends to increase, then the unemployment rate drops to a certain level known as natural state (Sasongko and Huruta 2019). Alternatively, it can be said that rate of inflation tends to decelerate, when the rate of unemployment increases above the natural rate.

A remarkable decline in the inflation rate has been experienced by the develop or emerging economies over the past half century (Wulandari et al. 2019). A first systematic and comprehensive analysis of inflation in the developing and emerging economies is given by “Inflation in Emerging and Developing Economies”. The paper examines the evolvement of inflation and the factors that drive the inflation domestically and globally. It cites the close relationship between inflation and unemployment in the developing economies and has indirect impact on the inequality and poverty (Ha et al. 2019). The association between the inflation and unemployment rate differ across the economies and it depends upon the period consideration and labour market structure. For instance, considering the Indian economy, it was found that there existed a short run trade-off between the unemployment and inflation.  

A research work conducting study on identifying the relationship between the unemployment and inflation in developing country such as Indonesia have found that the country experiences a one-way relationship between unemployment and inflation and the occurrence is at the third lag. It is shown by the function of impulse response that fluctuation of the inflation rate is in response to the unemployment shock. The rate of unemployment increases initially due to the shock from inflation and it diminishes eventually. In was shown that the shocks to the unemployment resulting from the inflation was only in the short term and the inflation rate did not impact unemployment both in the long and short run (Ho et al. 2019).

Another study examining the relationship between inflation rate and unemployment in Turkey showed that in general, there existed an inverse association between the rate if inflation and level of unemployment. It has been found that during the period when the rate of unemployment is high in the country, the rate of inflation is low and vice versa. Such relationship existed in the short run, however, in the long run, the evidence suggested that there do not exist any exchange between these two variables (Day?o?lu and Ayd?n 2020).

Relationship between inflation and unemployment

A study studying the impact of inflation on the unemployment in developing country such as Bhutan shows that in the short run, there exist a negative association with the rate of unemployment. However, in the long run, it was found that there existed positive relationship between the unemployment rate and inflation. The empirical results suggested that in the short run, the relationship between the inflation and unemployment is inverse indicting that for Bhutan, Philipps’s curve holds. With the increase in inflation, there is a decrease in unemployment implying that the price of goods and services increase with the increase in employment (Labonte 2016).  It is estimated that an increase in inflation by 1% decreases the unemployment rate by 0.299%. With the employment of more workers, there is an increase in their disposable income and thereby demanding more of the goods. Price of goods starts increasing until more is produced by the economy because of increase in the demand. However, in the long run, it is estimated that an increase in inflation rate by 1% increases the unemployment rate by 0.801% and such situation arise in particular, when there are no controlling measures adopted by the government to curb rising inflation (Girdzijauskas et al. 2022). It is required by the central government or the central bank of the country to control and monitor inflation. This is because inflation uncertainty results in lower economic growth due to lower level of investment and thereby results the unemployment to increase in the long run. The attempt of the government to lower the inflation has adverse impact on the economic growth in terms of increase in the unemployment rate. Hence, it is inferred that the measures taken by the government control the inflation comes with the cost in terms of change in the rate of unemployment over the period of change in inflation (Basu et al. 2019). From the overall analysis, it is inferred that the relationship between inflation and u employment for the developing economies is same in the short run. However, in the long run, the findings of the association between two variables seem to be positive for some country and unrelated for another country.

Impact of decrease in household monetary wealth would affect the consumption and thereby impact the aggregate demand curve. Since, decrease in wealth would lower the household income, consumption would be impacted and this results in the aggregate demand curve to shift leftward. (Singh 2018) At the new equilibrium, both the income and price would be lower and unemployment would be higher.

Inflation in emerging and developing economies

Initial equilibrium is at E₀ where short run aggregate supply curve (SRAS) intersects with the aggregate demand curve and the equilibrium income or GDP is determined at Y₀ and price is P₀. AD₀ shifts leftward to AD₁ due to decrease in the consumption resulting from decline in the monetary wealth of the household. The short run equilibrium is determined at E_1, where the new equilibrium income or GDP is determined at Y₁ and the equilibrium price level decreases to P₁.

Aggregate demand on a whole is impacted due to the changes in the exchange rate because of its direct impact on the import or export. An increase or appreciation in the value of exchange rate would make exports expensive, that is increase in Malaysian Ringgit would make exports expensive and less would be bought by the foreigners and vice versa (Tenzin 2019). In such situation, there would be an increase in imports by Malaysia and decrease in exports and thereby decreasing net exports as imports increasing and exports decreasing.

An appreciation of Ringgit impacts both the export and import of Malaysia, making export expensive and import cheaper. This results in increase in import and decrease in export and therefore, decreasing the net exports. It would impact the aggregate demand and shift the demand curve leftward from AD₁ to AD_2. Decrease in the aggregate demand would results in lower level of real GDP from Y₁ to Y₂ and lower level of price from P₁ to P₂. An appreciation in the exchange rate of Malaysia would cause the domestic GDP growth rate in relation to the foreign GDP increases because value of Ringgit relative to other currencies increases.

An increase in the price of capital would make it costly for the firm to produce the commodity. It is because capital is one of the factors of production and increase in the cost of capital increases the product price. Higher cost of production would discourage the firm to lower their supply and would cause the aggregate supply to decline.

The above graph demonstrates the impact of increase in capital price on real GDP using the framework of AD and AS. An increase in capital price would shift the aggregate supply curve upward from SRAS₁ and SRAS₂. It would result in lower level of real GDP and higher level of equilibrium price and the new short run equilibrium is determined at E₂, where P₂ and Y₂ are the price level of real GDP level respectively. Also, level of unemployment remains higher and the movement from E₁ to E₂ is known as stagflation, a period of higher price and lower output or income level.

Association between inflation and unemployment in developing economies

One of the factors determining the real GDP in the long run is the number of workers. Increase in the number of employed workers would increase the total productivity of the firm and thereby causes aggregate supply to increase. An increase in aggregate supply would increase the real GDP and pull down the price and lower level of employment (Trinh 2022).

The above graph depicts the impact of hiring workers on the aggregate supply and thereby on real GDP and price level. Initial equilibrium E₁ is represented by the intersection of SRAS₁ and AD₁, where P₁ and Y₁ are the equilibrium rice and income respectively. Hiring of labour incentivize the firms to increase their supply of goods and this shift the aggregate supply curve rightward. Rightward shift indicates an increase in the real GDP and decrease in the equilibrium level of price and lower level of unemployment.

When there is a nation-wide drought, the aggregate supply would decline causing the price to increase and a decline in the real GDP level.

The above graph shows the impact of drought on the real GDP and price level using the framework of AS-AD. Nationwide drought lasting for more than a month would cause the aggregate supply to decline as indicated by a movement from SRAS₁ to SRAS₂ and with the aggregate demand remaining same, there arises the situation of excess demand. This drives up the equilibrium price to a new level and price increases from P₁ to P₂ and results in a decline in the real GDP from Y₁ to Y₂.

Increase in labour productivity is associated with the increased in the output level generated by the firms in the economy. When the overall productivity increases, there is a change in aggregate supply and the aggregate demand remaining same, a situation of surplus arises which drives down the price to a low level (Antenucci et al.2019). Hence, real GDP increases due to increase in labour productivity and price level decreases.

The above graph shows that when productivity of labour increases, the aggregate supply in the economy increases causing the supply curve to shift to SRAS₂ from SRAS₁. Increase in supply and demand remaining same results in a situation of excess supply. It drives down the equilibrium price to a low level from P₁ to P₂ and increase in real GDP from Y₁ to Y₂.

A decrease in the business taxes can be interpreted as a decline in the cost of production for the firms. With lower cost of production, firms are motivated to increase their production which causes a shift in the supply curve. It would increase the real GDP and lower the price level.

The above graph shows that when productivity of labour increases, the aggregate supply in the economy increases causing the supply curve to shift to SRAS₂ from SRAS₁. Increase in supply and demand remaining same results in a situation of excess supply. It drives down the equilibrium price to a low level from P₁ to P₂ and increase in real GDP from Y₁ to Y₂.

Expectation of household about the decline in the prices would decrease their consumption in the present scenario (Lisi 2021). It is because they would be willing to buy more in the future when price declines. Hence, a decline in the consumption today would lower the aggregate demand.

The above graph depicts that the aggregated demand by consumer decreases because they reduce their consumption today with an intent of buying at lower price in future. It causes aggregate demand to shift from AD₁ to AD₂ and SRAS₁ remaining unchanged, the surplus created causes the real GDO and price level to decline.

Conclusion:

The overall paper presents the impact of different events on the supply and demand which is explained by the shift of the demand and supply curve respectively. When assessing the relationship between inflation and unemployment rate in the developing economies, it has been found that there exist inverse association between these variables in the short run and there is uncertainty concerning the association between them in the long run. Lastly, various external events have been analysed to determine the impact of real GDP and price level using the framework of AS-AD.  

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