Edgar, my cousin, is always thinking of the next business idea. His next business idea includes buying to gas stations. He believes that both gas stations would be profitable and allow revenue for him to increase. After recently reading an article named “$4-a-Gallon Gas Fueling Fears for Recovery” I decide to research the market in terms of supply and demand, elasticity, costs of production, pricing, and normal or economic profit or loss. In order to help my cousin Edgar I would like to provide him with the most informed advice possible. Owing to the fact that the crude oil prices have increased over the years, attempting into this business appears profitable. According to an online blog, people are facing extraordinary high prices of gasoline recently, and they are drained. American’s spending patterns have changed which have caused us to get used to higher prices of gasoline. Evaluations show that the demand from the Asia is increasing everyday leading to higher prices. Knowing these outcomes seems like a good option to invest in gas stations which have convenience stores. Although there might be chances that the shift in consumption patterns might take people away from gas stations due to driving less. The convenience stores can also hurt due to the fact that American will now have to budget more of their money to fuel costs. These changes might lead the economy to a situation where there is a very slow growth in consumption. Opening up a gas station requires a handsome investment, which is why it makes sense to study the past performances of the gas demand and supply in the United States. Along with studying the past performances of the gas demand and supply it is also wise to find out the predicted changes in the consumption. Also it makes sense to put a little thought on how the macroeconomic variables have been performing in the country and how they are supposed to perform, so that a complete assessment could be made before suggesting anything.
Relevant Economic Principles
Law of demand:
It says that everything else remaining equal, when the price of a product rises, its demand falls. Determinants of gasoline demand:
According to economics.about.com, if the real price of gasoline goes up, in the short run: a) The volume of traffic is supposed to go down by roundly 1% within about a year. b) The volume of fuel consumed can decrease by about 2.5% within a year. c) Fuel is being more efficiently used by an increased 1.5% within a year. d) The total number of vehicles owned goes down.
Now a meta-analysis explaining the variation in elasticity estimates of gasoline demand in the US by Molly Espey (1996) examined 101 different studies. He found that in the short-run a 10% hike in the price of gasoline lowers quantity demanded by 2.6%. The elasticity of demand:
Price elasticity of demand = Percentage change in quantity demanded/ Percentage change in price. So the average price-elasticity of demand for gasoline is calculated to be -0.26 in the short run. However, over a longer period of time the price elasticity of demand is calculated to be somewhat around -0.58. So while the demand for gasoline is very rigid in the short run, it is more flexible in the long run as has been studied by many like Dahl & Duggan (1998), etc. Law of supply:
Everything remaining constant when the price of a product increases, its quantity supplied increases.
Determinants of supply of gasoline:
The supply of gasoline is determined by many things: the price of the gas, the price of inputs, the technology used and advancements in the technologies, the taxes on the suppliers and their expectations regarding profits Price elasticity of supply:
In a blog on Welsker economics by Professor White head, the price of Gasoline was originally $7.50, and it was stable from Feb to July 2007, but when the price fell to $5.75 the quantity produced by Chesapeake Energy fell by 6%. So the percentage change in price here is...
References: Blanchard, Olivier, and Jordi Gali. 2007. “The Macroeconomic Effects of Oil Shocks: Why Are the 2000s So Different from 1970s.” NBER Working Paper No. 13368.
Brown, Stephen P.S. 2006. “Making Sense of High Oil Prices: A Conversation with Stephen P.A. Brown.” FRB Dallas Southern Economy, Issue 4, July/August, pp. 8-9.
Dahl, C. & Duggan, T. 1998. Survey of Price Elasticity from Economic Exploration Models of US Oil and Gas Supply. Journal of Energy Finance & Development, Volume 3, pp. 129‐169
Ponce, M. & Neumann, A. 2013. Elasticities of Supply for the US Natural Gas Market- Unpublished manuscript
Please join StudyMode to read the full document