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Analyze gasoline price hike statistics in the following scenario
Analyze gasoline price hike statistics in the following scenario. In June 2008, the U.S. retail gas price jumped from $3 to $4 a gallon. This is a 33% increase in price from January 2008. During that time, the total quantity of gasoline purchased fell by 3%. Supplies of gasoline produced also decreased from 1 million barrels to 800,000 barrels. No viable substitute has been created to replace gasoline. In a two-page paper, address the following.
a) Calculate the price elasticity of demand for gasoline.
b) Calculate the elasticity of supply using the information provided.
c) Calculate the changes in consumer and producer surplus.
d) Because there is no viable substitute for gasoline at this time, what can you say about the cross-elasticity and income elasticity of supply and e) demand for gasoline? Explain your answer and demonstrate clear, insightful critical thinking.
f) Is the demand for gasoline elastic, inelastic, perfectly elastic or inelastic, or unit elastic?
Expert Solution
a) The price elasticity of demand = percentage change in quantity / percentage change in price =3% / 33% = 0.091.
b) The percentage change in quantity supplied = (1,000,000 - 800,000) / 1,000,000 = 20%. The elasticity of supply = 20% / 33% = 0.91.
c) The reduction in consumer surplus = (1,000,000 - 800,000)*(4 - 3)/2 + 800,000*(4 - 3) = 900,000. To find the reduction in producer surplus, we need information on the marginal cost of producing 800,000 barrels. Assuming the marginal cost is $2, then the reduction in producer surplus = (3 - 2)*(1,000,000 - 800,000)/2 = 100,000.
d) Since there is no viable substitute, producers do not worry about losing to competitors when prices or income changes. Therefore, they will adjust quantity fairly easily when prices or income changes. Therefore, both cross-elasticity and income elasticity of supply will be fairly high.
e) Households cannot easily substitute gasoline using other alternatives, therefore cannot afford to adjust quantity of gasoline consumption when price and income changes. Therefore, the cross-elasticity and income elasticity of demand will be low.
f) The demand for gasoline is inelastic in this case because the price elasticity of demand is less than one.
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