Everyone’s Gasoline Problem

Crude oil and petroleum product prices can be affected by events that have the potential to upset the flow of oil and products to market, including geopolitical and weather-related developments.

These types of events may lead to actual disruptions or create uncertainty about future supply or demand, which can lead to higher volatility in prices. The volatility of oil prices is inherently tied to the low responsiveness or “inelasticity” of both supply and demand to price changes in the short run. Both the stock of oil-using equipment and oil production capacity are relatively fixed in the near-term. It takes years to develop new supply sources or vary production, and it is very hard for consumers to switch to other fuels or increase fuel efficiency in the near term when prices rise. Under such conditions, a large price change can be necessary to re-balance physical supply and demand following a shock to the system.

Assuming that the demand and supply for premium coffees are in equilibrium, the price will be at a constant, without significant pressure from the market. If Starbucks introduced the world to premium blends, this would cause a positive shift in the demand curve. When demand increases and supply remains unchanged, this leads to a higher equilibrium price and higher quantity.

As prices increase, and the market moves to a new equilibrium, we will generally see higher wages, more advances and investments in technology and infrastructure, and greater competition. In the long run, as production become more efficient and competition becomes greater, supply will increase and cause prices to settle back down. Several other factors will impact the long-term equilibrium, such as changes in supply. For example,

if a hard freeze eliminated Brazil’s premium coffee crop, this would cause a negative shift in the supply curve. Assuming demand remains constant, a negative shift in the supply curve will cause quantity to decrease and equilibrium price to increase. According to optionetics.com, in their analysis of the outlook for coffee prices in 2012 they noted, “in early August, a frost occurred in Brazil’s southeastern coffee growing belt…traders worried that next year’s yields could be hurt. At the same time, heavy rains during harvest forced Columbia to reduce its crop estimate for 2011.” (Chris Tyler)

Understanding the impact of problems along the supply chain and how the changes in supply will impact prices in the market allows real world investors to make predictions of price in the future. This is important for businesses along the supply chain as well, in order to “stay ahead of the curve” when making strategic business decisions.

Companies in this industry begin to see profits increasing due to the decline in production costs. Because there are no barriers to entry in perfect competition, the expectation is that new firms can enter this industry. Attracted by the high profits, new companies begin to produce this more profitable good. Stores find that more of this good is available and begin to lower prices in order to prevent a build up of inventory. This causes the profits levels to return to their prior levels.

The new firms have caused the supply of this good to increase, shifting the supply curve outward. Leaving the demand curve as it is, we can see that this outward shift results in a greater quantity sold at a lower price. Prices fall, as the market is flooded with the goods produced by the new start-ups. Consumers benefit since they are able to buy more of the good than they could previously. The market is then stable again, since there are no longer any economic profits to attract new entrants into the market.

BibliographyChris Tyler. Optionetics. 16 September 2011. 12 March 2012 <http://www.optionetics.com/marketdata/article.aspx?action=detail&aid=23986>. Stone, Gerald W. CoreEconomics. New York: Worth Publishers, n.d. U.S. Energy Information Administration. Independent Statistics & Analysis. 12 March 2012 <http://www.eia.gov/finance/markets/spot_prices.cfm>.