Economics Supply and Demand of Gasoline - Essay Example

Supply and Demand of Gasoline Gasoline is one of the main sources of energy which fuels internal combustion engines. This energy resource is vital for the global economy as it fuels the various sectors of the industry by making possible the transportation of goods and services as well as providing heat. In this regard, companies and even individuals are largely dependent gasoline to address their myriad needs. This paper discusses the condition of supply and demand of gasoline in the world market and how the interaction between these fundamental economic principles affects the price level for this petroleum product. Moreover, this paper zooms in on how the impact of Hurricane Katrina brought about the dramatic increase in gasoline prices. It also highlights some points on how gasoline price increases can be hampered or moderated. Gasoline Supply The gasoline price has ostensibly undergone extensive fluctuations mainly because of the product nature and the industry which supplies the world with oil. Note that a bulk of the aggregate oil output is produced by the Organization of Petroleum Exporting Countries (OPEC). This influential group is organized as a cartel and composed of nations in the Middle East including United Arab Emirates, Saudi Arabia and Kuwait among others. The main produce of these countries is oil and other petroleum products. Other countries, including the United States, are largely dependent on these countries for their oil supply (Case & Fair, 2002). With their rich oil resources, these nations created the cartel which has the ability to control member countries’ oil production capacity and output quotas of enabled them to collude to raise the oil price by. (“The Columbia Electronic Encyclopedia,” 2003) Given its mandate, supply of oil including gasoline is significantly affected by political unrest arising between these oil-exporting countries and other countries as well. To illustrate this point, supply of petroleum products was adversely affected by the war between Iran and Iraq in 1979. This tumultuous battle between two of the largest oil producers had caused a global oil supply shock and resulted in a dramatic increase in the price of oil. The limited oil supply then was further aggravated by the restricted means of transporting oil products to the rest of the world (“Wikipedia,” n.d.). Similarly, Iraq’s invasion of Kuwait that spawned the Gulf War also caused a leftward shift in the supply curve (Case & Fair, 2002) during early 1990’s. Aside from wars, OPEC also has the power to impose sanctions by restricting supply of oil product to other countries in light of political reasons. For instance, the cartel initiated an embargo on export oil and cut down supply as an indication their protest for western nations’ support of Israel. This caused a sharp leftward shift in oil supply curve and ultimately resulted in the severe escalation in the price of oil in 1973. (“Wikipedia,” n.d.) In terms of domestic supply, the United States recently encountered supply shortages brought about by Hurricane Katrina. It is reported that the calamity has adversely impacted the supply chain from the off-shore rigs in the Gulf Coast, which is the largest source of oil for the domestic market. The short-term shutdowns due to power outages during the peak of the hurricane affected two major on-shore pipelines. Furthermore, it was reported that at least 10% of the country’s refining capacity was not operational in the wake of the storm. (“Wikipedia,” n.d.) Apart from these, Louisiana, the epicenter of the hurricane and heavily devastated, also houses one of the main ports that serves as one of the most important inlets for oil imports (“Wikipedia,” n.d.). This means that supply is not only affected by the factors affecting actual production but also by the transportation of oil products. It is evident that Hurricane Katrina has disrupted the country’s ability to produce and at the same time deliver oil products like gasoline (“Wikipedia,” n.d.). The effect of the storm and the resulting reduction in oil supply on the price of oil products specifically gasoline is illustrated in Table 1 (Effect of Hurricane Katrina on Domestic Gasoline Price) below. Table 1 – Effect of Hurricane Katrina on Domestic Gasoline Price Since both the production and delivery of gasoline has been affected by the storm, the supply curve S1 shifted leftward to S2. Assuming the same level of demand, quantity supplied decreases while price of gasoline increases. This is exhibited during the first week of September 2005 as average retail price of gasoline reached the all-time high of $3.04 per gallon. This figure is comparable to the supply shock experienced in 1981 when gasoline price shot up to $3.03 per gallon (adjusted for inflation). (“Wikipedia,” n.d.) Gasoline Demand On the aspect of demand, oil or gasoline consumption substantially depends on the global economic condition. In this regard, there were notable cutbacks in oil demand during periods of economic downturns. For instance, the Asian crisis in 1997 and the 9/11 attacks in 2001 resulted in economic weakness which drove down the price of oil or gasoline. In times of dismal slumps, oversupply of oil and its related products arises due to weak demand, thus, putting a downward pressure on the price of oil or gasoline. On the other hand, an active economy has increasing demand for oil or gasoline resulting in the uptick in oil or gasoline prices. As an example, the United States has one of the biggest demands for petroleum products and accounts for almost one quarter of aggregate demand for oil (“Wikipedia,” n.d.). As the country is in the economic recovery stage, its energy requirement is apparently growing. To address the country would demand more oil or gasoline to fuel its commercial and industrial sectors. In the context of Hurricane Katrina, increase in the demand for oil causing a supply shortage in some states is attributed to panic buying. People bought more oil than usual in anticipation of a supply shortage. As a result, the meteoric rise in the price of oil and gasoline was experienced. Price System and Ways to Reduce Gasoline Price When the quantity demanded exceeds quantity supplied, as in the case of the United States when Hurricane Katrina devastated some states and crippled oil production and delivery, the prevailing market system or price system resulted in price rationing. As the supply becomes limited, oil supply was rationed to those who are willing to pay for higher prices. (Case & Fair, 2002) To manage oil supply and demand, the government has resorted to imposing alternative rationing system to distribute the available gasoline supply as experienced in 1974 (Case & Fair, 2002). Aside from this, it may also opt to undertake other measures to ensure efficiency in the oil market and regulate the price increases in oil products. As there is a general trend of upward movement in the price of oil and other oil products stimulated by more conducive investment scenarios, the government should be able to anticipate the upcoming price increases and bring forth solutions to ensure sufficient supply. Better yet, both the public and private sectors should endeavor to make industries less dependent on oil, gasoline and fossil fuels given that these non-renewable resources are gradually being depleted. Reducing the dependency of economies on oil and oil products would make them less vulnerable to supply and price fluctuations. Moreover, decrease in demand would cause a leftward shift in the demand curve (Case & Fair, 2002) and bring down price of oil or gasoline. Some companies have already recognized and invested on research of the potential of alternative resources such as fuel cell technology, hydrogen fuel, methanol, biofuels, solar energy, tidal energy and wind energy among others (“Wikipedia,” n.d.). References Case, K. & Fair, R. (2002). Principles of Economics, 7th ed. Prentice Hall Business Publishing. The Columbia Electronic Encyclopedia, 6th ed. (2003). Columbia University Press. Retrieved 22 November 2005, from http://www.answers.com. Wikipedia. (n.d.). Retrieved 22 November 2005, from http://en.wikipedia.org. Read More