demand elasticity

Topics: Supply and demand, Petroleum, Elasticity Pages: 8 (2229 words) Published: May 5, 2014
Demand elasticity
Supply internal external factors influence Economics for Business “Oil prices are high and constantly changing, but alternatives fuels are not an evident choice for motorists. Assume that oil begins to run out and that extraction becomes more expensive. Trace through the effects of this on the market for oil and the market for other fuels” This essay will examine the impacts of what diminishing oil supplies and rising extraction costs will have on both the market for fuels and alternative fuels. A market can be defined as a set of all actual and potential buyers of a product or service (Reference website) It will also look to examine in depth the effects in which this situation will have on both markets in terms of supply, demand and elasticity, Elasticity is a measure of the responsiveness od demand to a change in price. (Begg, D, & Ward, D, 2009,pp.36) Beginning with demand, demand is the quantities of a good or service that will be demanded over a period of time. Starting specifically with the demand for oil which is one of the world’s most precious resources and is extremely highly demanded, which therefore creates one of the fundamental economic problems between peoples unlimited want for oil versus a finite quantity of oil. Therefore shortages, coupled rising extraction costs will result in varied impacts on the oil market in terms of demand. Oil is a product which is seemingly inelastic; a product is “inelastic if a change in the price will lead to a proportionately smaller change in the quantity demanded”. (Begg, D, & Ward, D, 2009,pp.38) This conclusion is based upon a series of determinants of elasticity. Firstly the numbers of substitutes, substitutes are rival products; for example, a BMW car is a substitute for a Mercedes, or a bottle of wine from France is a substitute for a bottle from Australia.” (Begg, D, & Ward, D, 2009,pp.31) Oil has no substitutes which provide motorists with an adequate fuel for transport therefore enabling suppliers to set premium prices without massively affecting demand. An example of a substitute would be the electric car, but “the biggest disadvantage of electric cars is to find places to charge the vehicles” (Ohnsman, A, 2010, p10) which would cost “800 million dollars to establish charging facilities” (Ohnsman, A, 2010, p10) Therefore creating high barriers to entry for companies leaving oil to be a much more practical source of power thus contributing towards it remaining inelastic.

An additional determinant of elasticity is time, initially many products enter markets with few substitutes but as products become successful substitutes come into the market to compete. Oil has been in the market for a long time and has become fully established, time has therefore resulted in little competing substitutes to affect oils inelastic demand. On the other hand looking at a long term approach the market for substitutes is rising due to the inevitable consequence of oil being totally depleted. With “President Barack Obama aims to get a million electric cars and plug-in hybrids on U.S. roads by 2015 to ease U.S. reliance on imported oil and cut carbon emissions” (Ohnsman, A, 2010, p10) This plan to increase the supply of alternatives will therefore reduce the demand for oil, as many will look to switch to more fuel efficient cars and electric cars resulting in a reduced demand for oil. This could lead to the oil market becoming less inelastic as substitutes become more viable.

Figure 1.1 (Diagram showing oil is inelastic)
Figure 1.1 diagrammatically demonstrates the inelasticity of oil through a demand curve, A “demand curve illustrates the relationship between the price and quantity demanded of a particular product” (Begg, D, & Ward, D, 2009, pp.30) the demand curve helps to illustrate oils inelasticity. At point P0 representing the price of oil, the price is relatively low resulting in the quantity demanded represented by Q0 is high. When the...
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