Rise in price of input causes the supply of good to decrease ( Mankiw, 1998). Hence rise in the price of oil is likely to cause the supply of gasoline to fall. Supply curve of gasoline will shift to left and equilibrium price of…
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New equilibrium quantity has decreased from Q1 to Q2 and new equilibrium price has increased from P1 to P2.
Gasoline is the compliment of automobiles. Decrease in supply of gasoline is likely to push its price up. Hike in price of compliment tends to decrease the demand for good. In this case the demand for both luxury cars and economy cars will decrease. However due to differing nature of luxury and economy cars their demand will decrease in different proportions in response to change in price of gasoline. Luxury cars are likely to consume more gasoline hence their demand likely to be more responsive to increase in price of gasoline relative to economy cars that are fuel-efficient and take relatively little portion of consumption. Demand for luxury cars will, thus, decrease more than that of economy cars. These impacts are shown in following figures.
Horizontal axis shows the demand and supply quantity of luxury cars and y-axis represents their price. Initial equilibrium lie at point E1 where demand curve D1intersects supply curve S. Due to increase in price of gasoline demand curve shifts leftward i-e D2. New equilibrium is E2 where equilibrium quantity has decreased from Q1 to Q2 and equilibrium price has fallen from P1 to P2.
In case of economy cars the same phenomena would repeat. Demand curve for the economy cars will shift to left representing decreased demand for economy cars due to rise in price of gasoline. However the extent of decrement in the demand for economy cars is likely to be lesser relative to that of luxury cars.
As shown in diagram below, X-axis shows the quantity demanded and supplied of economy cars and Y-axis shows their corresponding price. Due to rise in price of gasoline demand curve D1 shifts leftward and new demand curve D2 appears. Initial equilibrium lie at point E1 where equilibrium quantity is Q1 and equilibrium price is P1. New demand curve D2 intersects supply curve S at point E2. At new
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