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Answers of Managerial Economics Homework #2
Chapter 5~Chapter 9

1.Using figure 5.3 as a basis, construct a series of four figures to show the effect of an increase in the demand for tanker service on the market price when (a) demand is extremely inelastic, (b) demand is extremely elastic, (c) supply is extremely inelastic, and (d) supply is extremely elastic.

Answer:

[pic]

[pic]

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2.Industry researchers R.S. Platou predicted that, between 2003–04, oil prices would fall by 5%, production of oil by OPEC and the former Soviet Union would increase, and deliveries of new tankers would exceed scrappage of older vessels. (Source: Platou Report 2004, www.platou.com).

a. Using suitable diagrams, explain how each of the following would affect the market for tanker services: (i) a fall in oil prices; (ii) an increase in production by OPEC and the former Soviet Union; (iii) new tanker deliveries; and (iv) scrappage of older vessels. b. Suppose that the net effect is to increase tanker rates. Illustrate the net effect on a single diagram. Explain the impact on the quantity of tanker services used. c. In actuality, oil prices increased by 25% between 2003 and 2004 and OPEC and the former Soviet Union production increased by about 10%. Modify your analyses in (a) for these changes.

Answer:
a) Fall in oil price would reduce the operating costs of tankers, and hence, increase the supply of tanker services. Increase in oil production would increase the demand for tanker services. New tanker deliveries would increase the supply of tanker services, while scrappage would reduce the supply. [pic]

b) Please refer to diagram below. Quantity of tanker services used could be higher or lower, depending on the elasticities of demand and supply. [pic]

c) In actuality, oil prices increased rather than fell. The net impact on the supply is ambiguous: it depends on which effect is larger – the increase in oil prices on the cost of tanker operations or the net increase in the tanker capacity. The revised figure is as follows: [pic]

3.In 2002, Iraq’s Kirkuk region exported 0.5–0.8 million barrels of crude oil per day (mpd) by pipeline to the Turkish port of Ceyhan. Following the U.S.-led coalition attack against Iraq, the pipeline was sabotaged and Kirkuk oil exports were disrupted. Refineries in western Europe switched to buying oil from the Urals in Russia, which produce oil that is chemically similar to Kirkuk. Urals oil is shipped to western Europe by tanker from the Black Sea through the Bosporus and Dardanelles. However, by early 2004, the surge in European demand and congestion in the Bosporus and Dardanelles had lifted spot tanker rates to €39,000 per day (Source: “Bosporus Tanker Congestion Threatens Shortage of Oil,” Financial Times, January 12, 2004).

a. Using suitable demand and supply curves, illustrate the short-run effects of pipeline disruption on the tanker services market. b. Using your diagram for (a), illustrate the long-run effects of the pipeline disruption. c. When political conditions in Iraq are restored to normal, exports by pipeline will resume, and the demand for tanker services will fall. With lower charter rates, the owner of a tanker must decide whether to continue operating, temporarily lay up, or scrap the vessel. Explain how the owner should choose among these alternatives.

Answer:
a) Pipeline disruption increased the demand for tanker services. [pic]
b) In the long run, the price would be higher than the original equilibrium, but lower than €39,000 per day. The quantity of tanker services would be higher than in the short run equilibrium, and in turn, higher than in the original equilibrium. c) The choice between operating and laying up is a short run decision. If the short run rate is below the average variable cost, the owner should lay up the tanker. The choice...
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