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Friday, June 01, 2007

Microeconomics quiz of the week

From this week's ProfessorJournal.com:
"With gasoline prices topping an average of $3.20 a gallon nationwide, OPEC officials say they see no reason to open their oil spigots wider. OPEC's new attitude reflects a tug of war in the global oil patch over how the profits from a barrel of oil are divvied up between the world's producers, which develop oil deposits and pump oil, and its refiners, which process it into fuels like gasoline. In recent years, the balance in the world's oil-supply system has shifted, giving the refining industry more power and more profit." The reason for the shift is a change in the refining industry: a movement to producing at capacity. The result of production approaching capacity, combined with a price inelastic demand for gasoline, is a rapid increase in the market price of gasoline. Refiners, however, counter that OPEC has played a big role in pushing up gasoline prices.

1.) Suppose the market for gasoline is perfectly competitive. Also, assume that as gasoline refining approaches capacity, price elasticity of market supply approaches zero. Approaching capacity, what is the effect of an increase in the price of crude oil in the market price of gasoline? (Intermediate microeconomics students: use the price elasticity of supply and the price elasticity of demand to determine the effect of an increase in the price of crude oil on the equilibrium price of gasoline.)

2.) Without any changes in the demand for gasoline (i.e., shifts in the demand function) is it possible that if OPEC would increase oil production that the price of gasoline would not decrease?

3.) What roles do refiners play in determining the price of gasoline?

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