Relationship Between Demand and Supply

1a)

 

Figure 1: Demand supply equilibrium in car petrol market in the UK

Source: (Created by the Author)

The market equilibrium of a product is achieved when quantity demanded for the product becomes equal to quantity supplied. Quantity demanded is the amount of goods and services that the consumers are ready to consume at different prices (Cook 2017). Again, quantity supplied is the amount of goods and services that the producers are ready to supply in the market at different prices. Law of demand explains the relationship between price and quantity demanded (Becker, Michael and Michael 2017). According to the law, if there is rise in price then the quantity demanded would fall and vice versa. The law thus indicated that the relationship between the said two market factors is inversely related. As a result, the demand curve is downward sloping.

Furthermore, law of supply explains the relationship between price and quantity supplied. As per the law, the rise in price leads to rise in quantity supplied and vice versa. Thus, the supply curve is upward sloping (Marwala and Hurwitz 2017). Now, equilibrium in market is determined by the movement of the demand and supply curves in a market. The case is similar with car petrol market in the UK. In Figure 1, D1 and S1 are the demand and supply curves respectively. With the movement of demand and supply curve in the market the equilibrium is attained at point E given in Figure 1. Hence, equilibrium occurs at the point where demand and supply curves intersect with each other (Breton 2017). At this intersection point the quantity demanded and quantity supplied are equal. The price of petrol given at this point is the equilibrium price and it is given as the P* and the corresponding the equilibrium quantity is Q*.

1b)

 

Figure 2: Impact of policy of the OPEC on car petrol market in the UK

Source: (Created by the Author)

OPEC is the organization the controls the global oil market. The organization has currently changed its policy and decided to extract less amount of crude oil. As a result, there would be less production of crude oil and thereby supply of the product in the market would fall. It should be noted that car petrol is produced from crude oil (Tiedemann 2020). Hence, it can be said that crude oil is an input required to produce car petrol. From theory of economics it is known that supply of a good is impacted by various factors that include production cost, production technology, and availability of inputs, government regulations, weather conditions and number of firms in the market (Hutchinson 2017). Hence, change in any of the above mentioned factors would lead to change in supply of a good.

Impact of OPEC Policy on Car Petrol Market in the UK

If there is fall in cost of production then supply increases because at lower cost of production supply increases because under the said condition with the same investment more production can be done. The opposite happens if cost of production increases. Again, with improvement in production technology there is rise in amount of production of a good. With rise in number of firms there is rise in production and thereby supply (Dean et al. 2020). The supply falls if the number of firms in a market reduces as lower number of firms means reduced production. Further, government regulations like tax, subsidy and the production quota could affect the supply of goods in a market. Weather conditions majorly affect production of goods whose process of production is influenced by weather.

In the given case, the policy of OPEC has lowered the production of crude oil. With reduction is production the supply of crude oil in the market would fall. As a result, there is fall in amount of crude oil available in the market required to produce the car petrol. Thus, there occurred a fall in availability of input in the car petrol market (Browning and Zupan 2020). Owing to this there is fall in production of car petrol in the market in the UK. It resulted in reduction in supply of car petrol in the UK causing the corresponding supply to left from S1 to S2 as given in Figure 2.  Consequently, the market equilibrium shifted to E1 from E. At the new equilibrium E1, the equilibrium price increased to P1 from P* and the equilibrium quantity decreased to Q1 from Q* in the car petrol market in the UK.

1c) 

 

Figure 3: Impact of imposition of price ceiling on car petrol market

Source: (Created by the Author)

The impact of OPEC policy found to increase the price of car petrol in the UK increased from initial equilibrium P* to P1. The price rise of petrol increases the burden on consumers and the government is determined to nullify this increased cost burden faced by the consumers. Thus, the objective of the government is to increase welfare of the consumers (Banerjee 2021). The government uses various market regulatory policies to control quantity and the price of goods and services. In the given case the government of the UK used price ceiling policy to protect the consumers from rising prices in the market for car petrol. Price ceiling is a government regulatory policy which is used to restrict sellers from charging price above a level fixed by the government.

Impact of Price Ceiling on Car Petrol Market in the UK

After OPEC’s policy there has been rise in equilibrium price of petrol to P1 but the government wants to keep the price as low as the initial equilibrium price P*. Due to this reason the government set price ceiling at P2, which is equal to P*. P* is lower than P1 and thus P2 is less than P1 as well (Hisham 2018). Due to fall in price from P1 to P2, there is a rise in quantity demanded from Q1 to Q* and alternatively the quantity supplied decreased from Q1 to Q2. It is should be noted that price and quantity demanded are inversely related and thus with fall in price there occurred and rise in quantity demanded. On the other hand, price and supplied quantity are positively related and hence with fall in price there occurred and fall in supplied quantity. Therefore, it is found that after imposition of price ceiling in the car petrol market in the UK there has been a shortage in the market since Q* is greater than Q2. The amount of market shortage is given by difference between Q* and Q2. This is an adverse effect of imposition of price ceiling on the car petrol market (Lam and Liu 2017). However, the impact is not limited to market shortage only. It is found that after imposition of price ceiling consumer and producer surpluses altered too.

Before price ceiling consumer surplus was given by the green and yellow shaded region shown in Figure 3. Similarly, under same condition the producer surplus was given by the red, blue and green shaded region in Figure 3. After price ceiling, consumer surplus decreased by yellow shaded region but increased by blue shaded region. Thus, price ceiling increased overall consumer surplus since blue shaded region is greater than yellow shaded region.  On the other hand, producer surplus after imposition of price ceiling decreased by red and blue shaded region.

Further, due to market shortage after price ceiling many consumers are not able to buy the amount of petrol they desired to buy. It indicates that the policy deprived many car petrol consumers in the UK. This led to fall in welfare in the car petrol market. The loss in welfare in the market is given by the yellow and red shaded region in Figure 3. These regions are called deadweight loss (DWL). Therefore, it can be said that imposition of price celling by the government of the UK has worsened the overall car petrol market condition in the UK.

1d)

Considering the impact of sudden price rise of car petrol in the UK after reduction in production of crude oil by the OPEC if the government of the UK imposes price ceiling policy in the market there price of car petrol would fall in the UK. As per (1c) the price after price ceiling returns to initial equilibrium P*, that is the price before OPEC decided to cut production. At this price the consumers would demand the amount of car petrol that was demanded at initial equilibrium. It should be noted that due to imposition of price ceiling quantity demanded increased (Chen et al. 2017).  However, with reduced price producers are not willing to supply that amount but quantity lower than that. Hence, after imposition of price ceiling quantity supplied declined. Therefore, price ceiling led to equilibrium where market shortage exists. It is found that the Brent Crude price has increased by 4.6% that led to rise in price of crude increased to $102 per barrel. It is thus evidence that there has been a rise in price of petrol in the UK. Due to this reason price per liter of petrol increased from £1.51 to £1.55 (BBC 2022). Due to this reason the expenses of car drivers increased. Considering this the government imposed price ceiling causing the price to drop. Fall in price helps the consumers to use cars more and thereby the quantity demanded would increase. Further, will fall in price profitability of the suppliers would fall and that is why they would lower supplied quantity. Therefore, consumers and suppliers reacted in an opposite way to the price ceiling imposed by the government of the UK. As a result of the reaction of the consumers and suppliers, the car petrol market faced shortage equilibrium.

 

Figure 4: ABC’s monopoly market

Source: (Created by the Author)

A monopoly firm like ABC has control over the price of the product as it is the only firm in the market and thus it has market power. The market power is strengthened by the presence of product uniqueness, network externalities and exclusive control over resources. As ABC can control price of the product offered by it, the demand curve faced by the firm is downward sloping (Alhadeff 2020). It means lower the price, higher will be the sales. In addition to that, marginal revenue curve faced by the firm is downward sloping and it is inside the demand curve since rate of fall in marginal revenue is greater than fall in quantity demanded. In monopoly, firms maximize profit by equating its marginal revenue and marginal cost (Zeuthen 2018). The equality point is given by the intersection point between marginal revenue and marginal cost curve as shown in Figure 4. It should be noted that profit maximizing quantity is determined using this equality point. Thus, the profit maximizing quantity of ABC is given by Q in Figure 4. Now, the profit maximizing price is determined by the point on demand curve that is corresponding to the quantity Q1. Hence, it is observable from the figure that profit maximizing price for ABC is given by P1. At this level of quantity cost per unit is determined from the AC curve given in Figure 4. Therefore, it can be said that profit earned by the ABC in the short run is calculated from point AC curve corresponding to profit maximizing quantity. Based on that, the profit of ABC in short run is shown as yellow shaded region Figure 4.

On the other hand, in the long run a monopoly like ABC determines its profit maximizing quantity and price suing the same method of MR = MC. In case of monopoly, barriers to entry in the market exist even in the long run. As a result, no new firms are able to enter the market of ABC in the long run. Thus, it can be said that ABC enjoys control over the market even in the long run. ABC is able to keep its network effects in the long run as well. The exclusive control over resources remains with ABC in the long run (Barney and Mackey 2018). Thus, only variable cost does not help the new firms to enter the market. Thus, in the long run with market power ABC is able to charge high price and earn positive economic profit like it does in the short run.

References

Alhadeff, D.A., 2020. Monopoly and competition in banking. University of California Press.

Banerjee, S., 2021. Intermediate microeconomics: A tool-building approach. Routledge.

Barney, J.B. and Mackey, A., 2018. Monopoly profits, efficiency profits, and teaching strategic management. Academy of Management Learning & Education, 17(3), pp.359-373.

BBC, 2022. UK petrol price jumps above £1.50 as oil costs rise (2022). Available at: https://www.bbc.com/news/business-60554128 (Accessed: 4 March 2022).

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Breton, A., 2017. The economic theory of representative government. Routledge.

Browning, E.K. and Zupan, M.A., 2020. Microeconomics: Theory and applications. John Wiley & Sons.

Chen, Y.H., Wen, X.W., Wang, B. and Nie, P.Y., 2017. Agricultural pollution and regulation: How to subsidize agriculture?. Journal of cleaner production, 164, pp.258-264.

Cook, P.J., 2017. The demand and supply of criminal opportunities (pp. 127-153). Routledge.

Dean, E., Elardo, J., Green, M., Wilson, B. and Berger, S., 2020. Price Ceilings and Price Floors. Principles of Economics: Scarcity and Social Provisioning (2nd Ed.).

Hisham, R., 2018. Consumer Right on Misleading Advertisement: A Development of Mobile Apps System to Lodge Report. Advanced Science Letters, 24(1), pp.626-630.

Hutchinson, E., 2017. 4.5 Price Controls. Principles of Microeconomics.

Lam, C.T. and Liu, M., 2017. Demand and consumer surplus in the on-demand economy: the case of ride sharing. Social Science Electronic Publishing, 17(8), pp.376-388.

Marwala, T. and Hurwitz, E., 2017. Supply and demand. In Artificial Intelligence and Economic Theory: Skynet in the Market (pp. 15-25). Springer, Cham.

Tiedemann, F., 2020. Demand-driven supply chain operations management strategies–a literature review and conceptual model. Production & Manufacturing Research, 8(1), pp.427-485.

Zeuthen, F., 2018. Problems of monopoly and economic warfare. Routledge.