Analyzing Economic Principles And Models: Impact Of Petrol Prices On Equilibrium Quantity And Price Essay.

Use ‘competitive market’ theory to explain how a rise in petrol prices will affect the equilibrium price and equilibrium quantity for motor cars.
To meet the requirements of the Marking Guide, students are strongly advised to complete the following steps: Assume illustrative figures and prices only.

1. a) Create imaginary demand and supply curves for motor cars in 2015 before the rise in petrol prices (say 2015). Use illustrative figures with scales on axes, label all curves and axes, identify the equilibrium price and quantity and create a diagram heading.
b) Replicate the same demand and supply diagram now showing how the equilibrium price and quantity for cars has changed (say between 2015 and 2018).

2. Choose and fully explain the relevant demand or supply determinant that initiated the pricing and production quantity change. Ensure you cite numerical examples from your second diagram to explain and illustrate the change.
3. Using competitive market theory, explain fully the ‘market force’ that caused the equilibrium price and quantity for cars to change. Students in their written descriptions are expected to refer to figures in their second diagram.
4. On a third diagram, show with brief supporting written commentary, what other circumstances/determinant/variable would need to have changed to allow the equilibrium price for cars to decrease, but for the equilibrium quantity of cars produced to remain unchanged.

The purpose of this assessment is to analyse economic principles and models. The decision making by individuals, enterprise and government is evaluated by using economic concepts and knowledge. The economic outcomes in market and its impact by the market structure and macroeconomic environment is described in this study. This assessment focuses on two scenarios. The first scenario highlights on how increase in petrol prices impact the equilibrium price and equilibrium quantity for motor cars. This scenario is explained with the help of competitive market theory. The second scenario explains about the price elasticity of demand for petrol.

Scenario One

1)a) Recent studies reflect that the Australian petrol prices are at highest level for the last three years. The petrol prices increased at highest level since the year 2015 owing to increasing  geopolitical tensions and supply cuts from OPEC and non- OPEC producers (Hall and Lieberman 2012). An imaginary demand and supply curves for motor cars in 2015 before the increase in petrol prices are shown below-

Imaginary demand and supply curve for motor cars

The above figure reflects that equilibrium occurs at the point E where demand curve (DD) and supply curve (SS) intersects each other. The corresponding equilibrium price of cars is P* and equilibrium quantity of cars is Q*.

1. b) The change in equilibrium price and quantity for motor cars is illustrated below-

Change in equilibrium quantity and price for cars

 The equilibrium point is ‘E’ where initial demand curve (DD) and supply curve (SS) cut each other at which equilibrium price is P*and equilibrium quantity is Q*. Increasing geopolitical tensions and cut in supply of petrol from OPEC and non- OPEC producers creates upward pressure for price of oil. Rise in price of petrol reduces the demand for motor cars. As a result, the demand curve shifts leftward from DD to D1D1. The new equilibrium point occurs at point E1 where initial supply curve (SS) cuts new demand curve (D1D1). As a result, the price decreases to P1 and quantity decreases to Q1. But most of the sellers were not willing to sell the cars at price P1 and thus wanted to sell the cars at price P2 (Taussig 2013).

2) One of the determinant that initiated change in pricing and production quantity of cars is geopolitical risks in Middle east along with supply cuts of petrol from OPEC as well as non- OPEC manufacturers that leads to rise in petrol price. According to ACCC (Australian Competition and Consumer Commission) report, the motorists of Australia are slugged with high petrol prices since the year 2015. The findings of ACCC revealed that average price in most of the regions in Australia increased by near about 12.6%.

This increase in petrol price was the outcome of few factors such as- exchange rate, refined prices of petrol, higher crude oil and high gross retail margins. It was evident from few facts that rising price of fuel highlighted increasing cost plaguing Australian businesses with retailers hitting hard by cost of rent, wages and transportation. Owing to rise in petrol prices, the demand for cars has decreased. Owing to decrease in demand for cars, the price as well as quantity of cars reduced. This in turn has decreased the sell of motor cars since the year 2015.

Scenario Two

Market force that caused the equilibrium price and quantity for cars to change is rise in petrol price owing to decrease in supply of petrol from OECD and non- OECD producers and geopolitical risk. The initial equilibrium price and quantity is P* and Q*. Rise in petrol prices makes a reduction in demand, which in turn lowers the equilibrium price from P* to P1 and equilibrium quantity from Q* to Q1. However, the new equilibrium price is P* and equilibrium quantity is Q* despite the fact that the quantity of cars provided is Q2. As a result, the supply of motor cars also decreases. 

Decrease in price of cars and quantity to remain unchanged

At the point when demand for motor cars decreased from DD to D1D1, the supply of cars would need to have increased to allow equilibrium price of cars to decrease and equilibrium quantity of cars produced to remain unchanged. The fall in price of cars from P* to P1 occurred due to rise in petrol prices that had been caused due to reduced supply of petrol (Sloman, Norris. and Garrett 2013). Moreover, the supply of cars might increase if the sellers continue to sell the cars at low price. Thus, the quantity of motor cars might remain unchanged even if its demand decreases.

Scenario Two

1)a) Price elasticity of demand for petrol signifies the sensitivity of percentage change in quantity demanded of motor cars to the percentage change in price of motor cars. The coefficient of elasticity mainly captures elasticity response between the two variables. The formula is written as-

Price elasticity of demand (PED) = percentage change in demand for quantity/percentage change in price of product

PED= change in the quantity demanded /change in price* price /quantity

The common formula for coefficient of price elasticity between the variables A and B is shown below-

Coefficient of elasticity = percentage change in the variable B/ percentage change in the variable A

C) The price elasticity of demand for petrol is 0.19. As the value of price elasticity of demand for petrol is less than 1, it can be said that the price elasticity of demand for petrol is inelastic (Rios, M.C., McConnell and Brue 2013). This means that slight change in price of petrol results in slight or no change in quantity demanded.

2) Assuming that the government of Australia has been considering taxes on petrol for increasing revenue. In this case, the price elasticity of demand for petrol is inelastic, which means that the certain change in quantity demanded of petrol does not change as that of its price. The higher inelastic the price elasticity of demand, the steeper is the curve. However, this means that the individuals purchase same amount of petrol even if its price rises (Kolmar 2017).

From the above figure, it can be seen that the suppliers earns P0*Q0of incomes at price P0. In any situation, the suppliers decreases the price to P1, he earns slightly higher income of P1*Q1. However, as the suppliers decreases the price of petrol from P0 to P1, the quantity demanded for petrol might increase slightly by Q0 to Q1. As a result, the suppliers can attain less profits from this product. Now, if the government increases tax on petrol, the tax revenue will slightly increase in case of inelastic demand.

3) Two reasons behind which the price elasticity of demand for petrol could be inelastic are described below-

1. a) No close substitute-this is one of the vital reason in case of petrol as there is no other option but to purchase petrol for filling up car. However, the firm can increase car price with decrease in its demand for petrol (Reisman 2013).
2. b) Lower percentage of consumers income- lower proportion of income leads to inelastic prce elastic of demand. Thus, higher the income proportion spent on the good, higher will be its price.

Conclusion

From the above discussion, it can be concluded that there are several factors that leads to change in price and quantity of product. Moreover, there are few factors that impact price elasticity of demand for a product. In addition to this, the suppliers also reviews the product price depending on price elasticity of demand.

References

Hall, R.E. and Lieberman, M., 2012. Microeconomics: Principles and applications. Cengage Learning.

Kolmar, M., 2017. Principles of Microeconomics. Springer International Publishing.

Reisman, D., 2013. The Economics of Alfred Marshall (Routledge Revivals). Routledge.

Rios, M.C., McConnell, C.R. and Brue, S.L., 2013. Economics: Principles, problems, and policies. McGraw-Hill.

Sloman, J., Norris, K. and Garrett, D., 2013. Principles of economics. Pearson Higher Education AU.

Taussig, F.W., 2013. Principles of economics (Vol. 2). Cosimo, Inc..