ECON1008 Principles Of Economics

1. The demand and supply models are the basic microeconomic concepts with the help of which market price and market equilibrium of a product can be determined. For a normal product, demand curve slopes downward to represent an inverse relationship between price and quality demanded (Gerakos and Syverson 2017). On the other side, supply curve for the product slopes upward to represent a positive relationship between price and quantity supplied. These concepts are applicable for both global and domestic oil markets. Higher price of oil can force consumers to consume this product by fewer amounts. With the help of these two models, the increasing oil price in global market and its impact on Australian petrol market can be described as well. Due to the strong global economic activity and restricted oil supply by major oil producing companies, the oil supply in international market has decreased (Kalcheva, McLemore and Pant 2018). However, demand for oil in this international market has remained same. Hence, due to this decreasing supply, oil price in this market has increased. This can be shown with the help of demand and supply curves of this market.

Figure 1: Demand and supply curves of petrol in global market

Source: (created by author)

In above figure S0 represents initial supply of oil in global market while D represents initial demand. As oil supply decreases, this global supply curve of oil has shifted from S0 to S1. Consequently, price of oil in this market increases from P0 to P1 while equilibrium amount of this product decreases from Q0 to q1.

This oil price increase in global market has led many countries to increase their domestic price of oil further. Price of oil in Australian market has also increased due to the same reason (Lederman and Porto 2015). The supply of this product in Australia has decreased while demand for it has remained same. This can be explained with the demand supply models.

Figure 2: Demand and supply curves of petrol in Australian market

Source: (created by author)

Figure 2 represents Australian oil market while supply decreases due to shortage of global oil supply. Consequently, price of oil in this domestic market increases from Pa0 to Pa1. OPEC and Non-OPEC countries have restricted oil supply to increase their revenue (ABC News. 2017).

2. Price elasticity of demand for a product can be determined with the help of its own price. If the product is elastic then a small change in price can change the demand for this product by large amount. In this situation demand curve becomes flatter. On the contrary, inelastic product implies that a small change in price cannot change the demand for this product significantly. Hence, the main determinant of price elasticity is the own price of the product. With the help of this concept, it can be analyzed that whether demand for oil in domestic market of Australia is elastic or not. In this country, petrol is the single product that consumers purchase by maximum amount (Olmstead et al. 2015). Therefore, this product can be referred as necessary one that each household and business origination demands every day to meet their requirements. Thus, increase in price of petrol affects the budget of each household and cost of production for each company, adversely. Consequently, to offset this budget deficit, those consumers decrease their consumptions of other products significantly (Murjani 2017). According to this statement, it can be said that petrol is an inelastic product and consequently it has stepper demand curve.

Figure 3: Inelastic demand curve for Petrol

Source: (created by author)

Figure 3 represent inelastic demand curve for petrol in Australian market. Due to this type of demand curve, revenue of petrol station has increased significantly. This is because people cannot reduce their consumption of this oil. Hence, they can buy same amount of oil with comparatively higher prices and consequently total revenue of a petrol station can increase by comparatively higher amount. This is not possible for an elastic product as higher price of product can decrease its demand by large amount. In this context, revenue of seller can be decreased further compare to before.

Figure 4: Amount of revenue for both elastic and inelastic product

Source: (created by author)

Figure 4 (a) represents elastic demand curve for Petrol. As price of oil increases in Australia from Pp0 to Pp1, revenue of petrol station increases as well. Figure 4 (b) represents an elastic supply curve with similar economic phenomenon. However, in this figure, increase in price is low compare. Hence, the amount of revenue for a product with elastic demand curve is low compare to the amount of revenue of an inelastic demand curve.Answer 3:

As the government imposes tax on Petrol, producers can reduce their supply. Thus, the curve can shift towards left and consequently market price of this product can increase further. This tax is considered as indirect one. Thus, the government imposes this tax on the sellers though consumers pay the ultimate amount of tax (Coglianese, Davis, Kilian and Stock 2017). Hence, the amount of consumer’s surplus decreases. On the other side, producers reduce their supply of due to higher prices (Appleyard and Chesbrough 2017). Thus, producer’s surplus can be decreased as well.

Figure 5: Consumer surplus and producer surplus

Source: (created by author)

After imposition of tax, supply curve of petrol shifts from S0 to S0+t in figure 5. The initial amount of consumer surplus is AFP0. However, after tax imposition, this amount becomes AFP1 while AFP1 < AFP2. On the other side, initial amount of producer surplus is CDP0. After tax, this amount becomes BFP1 while BFP1< CDP0. Hence, from above diagram it can be said that both consumer and producer surplus decrease after tax.

References:

ABC News. 2017. Why is petrol so expensive? Global oil deals and the Reserve Bank's dilemma. [online] Available at: https://www.abc.net.au/news/2017-12-27/why-petrol-expensive-global-oil-deal-opec-reserve-bank-dilemma/9287666 [Accessed 5 Jul. 2018].

Appleyard, M.M. and Chesbrough, H.W., 2017. The dynamics of open strategy: from adoption to reversion. Long Range Planning, 50(3), pp.310-321.

Coglianese, J., Davis, L.W., Kilian, L. and Stock, J.H., 2017. Anticipation, tax avoidance, and the price elasticity of gasoline demand. Journal of Applied Econometrics, 32(1), pp.1-15.

Gerakos, J. and Syverson, C., 2017. Audit firms face downward-sloping demand curves and the audit market is far from perfectly competitive. Review of Accounting Studies, 22(4), pp.1582-1594.

Kalcheva, I., McLemore, P. and Pant, S., 2018. Innovation: The interplay between demand-side shock and supply-side environment. Research Policy, 47(2), pp.440-461.

Lederman, D. and Porto, G., 2015. The price is not always right: on the impacts of commodity prices on households (and countries). The World Bank Research Observer, 31(1), pp.168-197.

Murjani, A., 2017. Energy Goods Demand in Tabalong Regency. Jurnal Bina Praja: Journal of Home Affairs Governance, 9(2), pp.307-319.

Olmstead, T.A., Alessi, S.M., Kline, B., Pacula, R.L. and Petry, N.M., 2015. The price elasticity of demand for heroin: matched longitudinal and experimental evidence. Journal of health economics, 41, pp.59-71.