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Chapter 6: Problem 4

(Related to the Apply the Concept on page 203) An article in the Wall Street Journal notes that although U.S. oil production has increased rapidly in recent years, the increase has still amounted to only 5 percent of world production. Still, that increase has been "enough to help trigger a price collapse." Briefly explain under what circumstances a small increase in supply can lead to a large decline in equilibrium price.

Short Answer

Expert verified
A small increase in supply can lead to a large decline in equilibrium price when the demand for the product is inelastic. In the case of the oil industry, a 5% increase in supply can decrease global prices significantly due to the inelastic nature of oil demand, as consumers continue to buy oil products even with price variations, due to the lack of substitutes.

Step by step solution

01

Understanding Equilibrium

Equilibrium is the state where supply equals demand. When supply increases, while demand remains unchanged, a surplus occurs, leading to a lower equilibrium price. This step involves understanding the basic principles of supply and demand.
02

Applying Supply Increases

An increase in the supply of a product usually results in a decrease in its price. In the exercise, the supply of oil has increased by a small percentage (5%). Apply this concept to understand the changes in the oil market scenario.
03

Understanding Price Elasticity

Price elasticity of demand refers to how changes in price will affect the quantity demanded. The greater the elasticity, the larger the impact of a change in supply on price. In the exercise, the demand for oil is usually inelastic though, because consumers continue to buy oil products even when prices increase, due to the lack of substitutes.
04

Relating Elasticity and Supply Increase

The small increase in supply and the inelastic nature of demand for oil could mean that any increase in supply can lead to significant changes in price. Here, it's important to understand that although the increase in supply is 5% of world production only, it can have a significant effect on global prices because of the relative inelasticity of demand for oil.

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Most popular questions from this chapter

An article in the New York Times about the New York Metropolitan Opera (the Met) suggested that the popularity of opera might be increased if the Met reduced its ticket prices. But the article observed that such ticket price cuts would be possible only if the Met received a gift from "a very deep- pocketed donor." What were the authors of the article assuming would happen to the Met's revenue following the cut in ticket prices? What were they assuming about the price elasticity of demand for tickets to the Met? Briefly explain.

The price elasticity of demand for crude oil in the United States has been estimated to be -0.06 in the short run and -0.45 in the long run. Why would the demand for crude oil be more price elastic in the long run than in the short run?

What is the main determinant of the price elasticity of supply?

The entrance fee into Yellowstone National Park in northwestern Wyoming is " 30 for a private, noncommercial vehicle; \(\$ 25\) for a motorcycle or a snowmobile; or \(\$ 15\) for each visitor 16 and older entering by foot, bike, ski, etc." The fee provides the visitor with a seven-day entrance permit into Yellowstone and nearby Grand Teton National Park. a. Would you expect the demand for entry into Yellowstone National Park for visitors in private, noncommercial vehicles to be elastic or inelastic? Briefly explain. b. There are three general ways to enter the park: in a private, noncommercial vehicle; on a motorcycle; and by foot, bike, or ski. Which way would you expect to have the largest price elasticity of demand, and which would you expect to have the smallest price elasticity of demand? Briefly explain.

One study found that the price elasticity of demand for soda is -0.78 , while the price elasticity of demand for Coca-Cola is \(-1.22 .\) Coca-Cola is a type of soda, so why isn't its price elasticity the same as the price elasticity for soda as a product?
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