Econ 545: Microeconomic Analysis
Microeconomic Analysis – Situation C
Econ 545
Introduction Edgar is an investor who sees the high gas prices as a chance to make money from American consumers and their constant demand of gasoline, and soon a large demand from increasing car sales in India and China. Over the past several years the increase in crude oil price resulted in a drastic increase in gasoline prices setting record highs every summer. Consumers had to change their way of living, and savvy investors saw this as an opportunity to get in on making a profit, and this is what Edgar plans to do with the two gas stations he wants to purchase. This investment can easily become a nightmare if the gas stations do not produce enough revenue to cover expenses such as paying back the loans needed for the initial purchase, or increasing maintenance costs. But recently crude oil prices have plummeted and this new development can be a prelude to decreasing profits from gas stations. The analysis provided below will discuss …show more content…
reasons for purchasing the gas station as well as future indications on what to expect about gasoline in the future.
Demand Determinants The price of crude oil which is refined into gasoline has a direct effect on demand set by consumers. While the price does fluctuate as for any commodity, crude oil and gasoline is special in that it follows an inelastic demand curve. This is to say as the price increases the quantity demanded will be decreased, but not by much since gasoline is necessary for many aspects of a daily routine. Consumers therefore sacrifice other spending habits like eating out at a restaurant or traveling to a vacation spot by car or shopping all at one location rather than multiple locations. This can have a huge impact on tourist destinations such as national parks or beach towns during summer vacations, with more people choosing closer and more local destinations, or simply staying at home in a new term called “Staycation” (Staycation Definition, 2015). Consumers are becoming more sensitive to gasoline prices and are adjusting their lifestyles accordingly to fit within their budget and may respond favorably if gasoline prices drop below the $4 per gallon mark. With the consumer sensitivity toward gasoline prices, a few notable changes are occurring on the road. In a meta-analysis done by Espey (1996), it was found that as gasoline prices rose by 10%, the demand lowered by 2.6%, which leads to a decrease in the volume of traffic, decrease in fuel consumption, and increase in fuel efficiency, all in the name of saving money at the gasoline station. While the demand may dip in the beginning as the price increases, the demand will slowly rise back up as consumers become adjusted to the change and see the need for gasoline as necessary in their daily lives. As demonstrated by the graph below taken from the Economic and Statistics Administration website, the gasoline price increase also affects the expenditures of a person and the household.
The equation for Price-Elasticity of Demand is (Glenn, 2012):
Based on a study done by Hughes, Knittel, and Sperling in 2008, the price elasticities ranged from -0.034 to -0.077 from 2001 to 2006. These are short-run price elasticities which mean that as the price is increasing for gasoline, people will still purchase it at whatever price during this time period. But later in the long-run, the value will change because people will find alternatives and then the demand will become elastic. The values in an Inelastic Demand should always be negative since the numerator will be negative due to a decrease in demand while the denominator is positive reflecting the increase in price. This value will be less than 1 in absolute value and as the study above shows the values calculated were -0.034 to -0.077 from years 2001 to 2006. Consumers will in the short-run purchase a slightly less amount of gasoline due to the price, but in the long-term consumers will become resourceful and look into alternatives for transportation rather than spending more at the pump. Such alternatives are carpooling, buses, trains, bikes, even working from home if possible. With the advent of hybrid vehicles such as the Prius and now the electric car line Tesla, consumers have a wider array of fuel-efficient transportation modes available. The Prius can get about 50 miles to the gallon (Toyota Prius, 2015) and the Tesla can go almost 300 miles on a single charge (TeslaMotors.com, 2015). With these new cars, the demand for fuel will decrease, which might bring down the price of gasoline as a means to attract consumers that have less efficient vehicles. The supply of crude oil comes from either domestic supplies or foreign countries. With foreign crude oil the price is controlled and influenced by the relationship between the two countries and the value of the United States Dollar in the world market. The recently approved Keystone XL Pipeline will provide America with almost half of all crude oil by 2020, and in numbers that means from the 2010 production of 5.5 million barrels per day will be increased to 7.5 million barrels per day by 2019 (Kalen, 2012). This will lessen the dependency on foreign oil and remove the need to purchase turbulent and high priced crude oil from countries with links to possible terrorism, increasing national security, and providing jobs for the duration and maintenance of the pipeline (Slade, 2012). The amount of gasoline sold per station in one month on average in California was 132,000 gallons in 2012 (Retail Fuel Report, 2012).
Supply Determinants The finite supply of crude oil and the daily fluctuating price of crude oil per barrel are the biggest supply determinant factors that need to be addressed before purchasing the gas stations. Currently, a barrel of crude oil costs $59.29 for the month of December 2014, a record low for the past 4 years. The graph below shows seasonal variance of price per barrel.
The table below shows in numbers just how much of the prices have gone down since the spring of 2014. The summer months mean vacation and prices tend to go up for the short-run because of inelastic demand. But the winter holidays should have also experienced an increase in gasoline price, but this was not so as the crude oil price fell, and was reflected in gasoline prices.
Both graph and charts were taken from Petroleum & Other Liquids from the U.S. Energy Information Administration (2015) website. The consumption of oil is steadily increasing as more people are able to purchase vehicles whether it is fuel efficient or not. The graph below shows that the United States currently consumes about 1/4th of the supply of crude oil processed from natural reserves from the study done by Polách and Virglerová in 2011.
As this trend increases, the supply of crude oil will eventually run out and as a result the price will increase due to scarcity of the product. To show if price is related to supply of crude oil, Polách and Virglerová calculated the regression of oil proved reserves to price and the R-squared value was found to be 80.7% meaning that the data points were 80.7% of the time close to the fitted line showing a strong relationship between price and proved oil reserves.
Unfortunately, there is no research for the recent price drop of crude oil and the impact on gasoline demand and supply, but a prediction can be made that as price decreases on a once expensive commodity, consumers will purchase more of it before the price increases. The cost of buying a gas station can be approximated to be about $1 million using a few different website that deal with selling gas stations, with higher cash flow stations selling for much more. Fixed costs would include rent on the building, salaries of employees, utilities, taxes, and insurance. Variable costs would be cost of inventory in this case any consumable items in the gas station and hourly wages. A sunk cost would be the gas station pumps which could be costly as discussed below.
Technology upgrade and gas station maintenance has not progressed much further from a pay at the pump point of sale, but with the increasing use of smartphones that have credit card information stored, there might be future scanners that allow for consumers to use their phones to pay and could be more secure than using a credit card. Maintenance of gasoline storage tanks may need to be inspected or replaced in the long term, and short term maintenance would be making sure the pumps are dispensing properly and monitoring for wear and tear from daily use. For example, a gasoline dispenser found at the gas station could cost about $8,500 new, or less for used and refurbished (Gilbarco Encore 300, 2013). The possibility of owning two gas stations as a business venture has the expectation of making a profit or at the very least cover the expenses through revenue made. With the recent drop in gasoline prices, privately owned gas stations have reported net profit margins of about 3% in 2013 compared to 0.9% profit margin in 2009 (Biery, 2014). These net profit margins are much lower than retailers which averaged about 8% in 2013 in the same article, and while 70% of sales are gasoline, 36% is the profit made from the gasoline sales, and the rest is made up of sales of food products, tobacco, and alcohol. No data was found yet on profits made during the past quarter where the most decrease in gasoline prices were made, but a prediction can be made that profits might have rose even more with consumers visiting the gas stations more frequently. The price elasticity of supply is calculated much like the price elasticity of demand (Glenn, 2014):
Using the U.S. Energy Information Administration website, the price of elasticity was calculated using the following variables:
Year
Price
Barrels (Thousands)
2014
$ 59.29
385,455
2013 $ 97.63
360,567
Percent Change
-39%
7%
Price Elasticity of Supply = 0.176
The value of 0.176 is very close to the class textbook value of 0.20 on page 190, and this means the supply is inelastic since it is less than 1. The price elasticity of demand was also less than 1 and was considered inelastic for the short term but elastic in the long term, and the same can be said for the price elasticity of supply.
Recommendations and Economic Justification Crude oil is a staple of many other products like plastics but the most profitable part of crude oil remains gasoline.
As the world population continues to increase in wealth and ability to purchase a car, the demand for gasoline will rise and the supply must keep up. The interface between the suppliers of gasoline and the consumer is the gas station with daily changing prices for a gallon of gasoline. The variance of prices will either drive consumers away or bring them in, especially during peak travel seasons like summer and winter. The technological advancements of fuel efficient vehicles are a major competitor against gasoline, and with the specific engines becoming more popular ever year, the dependency on gasoline might weaken over the next few decades. Still, as for the present time gas stations are a necessity and with the current drop in gas prices the opening of two gas stations should have a stable flow of consumers leading to some profits after initial start-up
costs.
References
Biery, M.E. (2014). Why Gas Station Owners May Be Smiling. Forbes. http://www.forbes.com/sites/sageworks/2014/01/21/profit-margins-at-gasoline-stations-have-increased/
Espey, M. (1996). Explaining the variation in elasticity estimates of gasoline demand in the United States: A meta-analysis, The Energy Journal, 17(3): 49-60
Glenn, R., Anthony Patrick. (2012). Economics, 4th Edition.
Hughes, J. E., Knittel, C. R., & Sperling, D. (2008). Evidence of a Shift in the Short-Run Price Elasticity of Gasoline Demand. Energy Journal, 29(1), 113-134.
How much tax do we pay on a gallon of gasoline and diesel fuel? U.S. Energy Information Administration. January 20, 2015. http://www.eia.gov/tools/faqs/faq.cfm?id=10&t=10
KALEN, S. (2012). THIRST FOR OIL AND THE KEYSTONE XL PIPELINE. Creighton Law Review, 46(1), 1-25.
New Gilbarco Encore 300 with Monochrome CRIND. Paul & Associates. 2013. http://www.paulandassoc.com/products/gilbarco-encore300/
Petroleum & Other Liquids. U.S. Energy Information Administration. January 22, 2015. http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=pet&s=rwtc&f=m
Polách, J., & Virglerová, Z. (2011). OIL PRICES AND ITS DEPENDENCE ON OIL RESERVES. Scientific Papers Of The University Of Pardubice. Series D, Faculty Of Economics & Administration, 16(22), 155-164.
Reasons to Break America’s Addiction to Foreign Oil. Economics & Statistics Administration. http://www.esa.doc.gov/Blog/2011/05/18/three-more-reasons-if-we-needed-more-break-americas-addiction-foreign-oil June 29, 2011.
Retail Fuel Report and Data for California. Energy Almanac. 2012. http://energyalmanac.ca.gov/gasoline/piira_retail_survey.html
SLADE, E. (2012). THE KEYSTONE PIPELINE ADDITION: ASSESSING THE POTENTIAL BENEFITS OF REDUCED GASOLINE PRICES AND INCREASED NATIONAL SECURITY. Creighton Law Review, 46(1), 27-60.
Staycation Definition. Investopedia. http://www.investopedia.com/terms/s/staycation.asp Retrieved January 22, 2015.
Tesla Motors. Tesla. 2015 http://my.teslamotors.com/goelectric#range Retrieved January 22, 2015
Toyota Prius. Toyota. 2015. http://www.toyota.com/prius/ Retrieved January 22, 2015
Econ 545
Introduction Edgar is an investor who sees the high gas prices as a chance to make money from American consumers and their constant demand of gasoline, and soon a large demand from increasing car sales in India and China. Over the past several years the increase in crude oil price resulted in a drastic increase in gasoline prices setting record highs every summer. Consumers had to change their way of living, and savvy investors saw this as an opportunity to get in on making a profit, and this is what Edgar plans to do with the two gas stations he wants to purchase. This investment can easily become a nightmare if the gas stations do not produce enough revenue to cover expenses such as paying back the loans needed for the initial purchase, or increasing maintenance costs. But recently crude oil prices have plummeted and this new development can be a prelude to decreasing profits from gas stations. The analysis provided below will discuss …show more content…
reasons for purchasing the gas station as well as future indications on what to expect about gasoline in the future.
Demand Determinants The price of crude oil which is refined into gasoline has a direct effect on demand set by consumers. While the price does fluctuate as for any commodity, crude oil and gasoline is special in that it follows an inelastic demand curve. This is to say as the price increases the quantity demanded will be decreased, but not by much since gasoline is necessary for many aspects of a daily routine. Consumers therefore sacrifice other spending habits like eating out at a restaurant or traveling to a vacation spot by car or shopping all at one location rather than multiple locations. This can have a huge impact on tourist destinations such as national parks or beach towns during summer vacations, with more people choosing closer and more local destinations, or simply staying at home in a new term called “Staycation” (Staycation Definition, 2015). Consumers are becoming more sensitive to gasoline prices and are adjusting their lifestyles accordingly to fit within their budget and may respond favorably if gasoline prices drop below the $4 per gallon mark. With the consumer sensitivity toward gasoline prices, a few notable changes are occurring on the road. In a meta-analysis done by Espey (1996), it was found that as gasoline prices rose by 10%, the demand lowered by 2.6%, which leads to a decrease in the volume of traffic, decrease in fuel consumption, and increase in fuel efficiency, all in the name of saving money at the gasoline station. While the demand may dip in the beginning as the price increases, the demand will slowly rise back up as consumers become adjusted to the change and see the need for gasoline as necessary in their daily lives. As demonstrated by the graph below taken from the Economic and Statistics Administration website, the gasoline price increase also affects the expenditures of a person and the household.
The equation for Price-Elasticity of Demand is (Glenn, 2012):
Based on a study done by Hughes, Knittel, and Sperling in 2008, the price elasticities ranged from -0.034 to -0.077 from 2001 to 2006. These are short-run price elasticities which mean that as the price is increasing for gasoline, people will still purchase it at whatever price during this time period. But later in the long-run, the value will change because people will find alternatives and then the demand will become elastic. The values in an Inelastic Demand should always be negative since the numerator will be negative due to a decrease in demand while the denominator is positive reflecting the increase in price. This value will be less than 1 in absolute value and as the study above shows the values calculated were -0.034 to -0.077 from years 2001 to 2006. Consumers will in the short-run purchase a slightly less amount of gasoline due to the price, but in the long-term consumers will become resourceful and look into alternatives for transportation rather than spending more at the pump. Such alternatives are carpooling, buses, trains, bikes, even working from home if possible. With the advent of hybrid vehicles such as the Prius and now the electric car line Tesla, consumers have a wider array of fuel-efficient transportation modes available. The Prius can get about 50 miles to the gallon (Toyota Prius, 2015) and the Tesla can go almost 300 miles on a single charge (TeslaMotors.com, 2015). With these new cars, the demand for fuel will decrease, which might bring down the price of gasoline as a means to attract consumers that have less efficient vehicles. The supply of crude oil comes from either domestic supplies or foreign countries. With foreign crude oil the price is controlled and influenced by the relationship between the two countries and the value of the United States Dollar in the world market. The recently approved Keystone XL Pipeline will provide America with almost half of all crude oil by 2020, and in numbers that means from the 2010 production of 5.5 million barrels per day will be increased to 7.5 million barrels per day by 2019 (Kalen, 2012). This will lessen the dependency on foreign oil and remove the need to purchase turbulent and high priced crude oil from countries with links to possible terrorism, increasing national security, and providing jobs for the duration and maintenance of the pipeline (Slade, 2012). The amount of gasoline sold per station in one month on average in California was 132,000 gallons in 2012 (Retail Fuel Report, 2012).
Supply Determinants The finite supply of crude oil and the daily fluctuating price of crude oil per barrel are the biggest supply determinant factors that need to be addressed before purchasing the gas stations. Currently, a barrel of crude oil costs $59.29 for the month of December 2014, a record low for the past 4 years. The graph below shows seasonal variance of price per barrel.
The table below shows in numbers just how much of the prices have gone down since the spring of 2014. The summer months mean vacation and prices tend to go up for the short-run because of inelastic demand. But the winter holidays should have also experienced an increase in gasoline price, but this was not so as the crude oil price fell, and was reflected in gasoline prices.
Both graph and charts were taken from Petroleum & Other Liquids from the U.S. Energy Information Administration (2015) website. The consumption of oil is steadily increasing as more people are able to purchase vehicles whether it is fuel efficient or not. The graph below shows that the United States currently consumes about 1/4th of the supply of crude oil processed from natural reserves from the study done by Polách and Virglerová in 2011.
As this trend increases, the supply of crude oil will eventually run out and as a result the price will increase due to scarcity of the product. To show if price is related to supply of crude oil, Polách and Virglerová calculated the regression of oil proved reserves to price and the R-squared value was found to be 80.7% meaning that the data points were 80.7% of the time close to the fitted line showing a strong relationship between price and proved oil reserves.
Unfortunately, there is no research for the recent price drop of crude oil and the impact on gasoline demand and supply, but a prediction can be made that as price decreases on a once expensive commodity, consumers will purchase more of it before the price increases. The cost of buying a gas station can be approximated to be about $1 million using a few different website that deal with selling gas stations, with higher cash flow stations selling for much more. Fixed costs would include rent on the building, salaries of employees, utilities, taxes, and insurance. Variable costs would be cost of inventory in this case any consumable items in the gas station and hourly wages. A sunk cost would be the gas station pumps which could be costly as discussed below.
Technology upgrade and gas station maintenance has not progressed much further from a pay at the pump point of sale, but with the increasing use of smartphones that have credit card information stored, there might be future scanners that allow for consumers to use their phones to pay and could be more secure than using a credit card. Maintenance of gasoline storage tanks may need to be inspected or replaced in the long term, and short term maintenance would be making sure the pumps are dispensing properly and monitoring for wear and tear from daily use. For example, a gasoline dispenser found at the gas station could cost about $8,500 new, or less for used and refurbished (Gilbarco Encore 300, 2013). The possibility of owning two gas stations as a business venture has the expectation of making a profit or at the very least cover the expenses through revenue made. With the recent drop in gasoline prices, privately owned gas stations have reported net profit margins of about 3% in 2013 compared to 0.9% profit margin in 2009 (Biery, 2014). These net profit margins are much lower than retailers which averaged about 8% in 2013 in the same article, and while 70% of sales are gasoline, 36% is the profit made from the gasoline sales, and the rest is made up of sales of food products, tobacco, and alcohol. No data was found yet on profits made during the past quarter where the most decrease in gasoline prices were made, but a prediction can be made that profits might have rose even more with consumers visiting the gas stations more frequently. The price elasticity of supply is calculated much like the price elasticity of demand (Glenn, 2014):
Using the U.S. Energy Information Administration website, the price of elasticity was calculated using the following variables:
Year
Price
Barrels (Thousands)
2014
$ 59.29
385,455
2013 $ 97.63
360,567
Percent Change
-39%
7%
Price Elasticity of Supply = 0.176
The value of 0.176 is very close to the class textbook value of 0.20 on page 190, and this means the supply is inelastic since it is less than 1. The price elasticity of demand was also less than 1 and was considered inelastic for the short term but elastic in the long term, and the same can be said for the price elasticity of supply.
Recommendations and Economic Justification Crude oil is a staple of many other products like plastics but the most profitable part of crude oil remains gasoline.
As the world population continues to increase in wealth and ability to purchase a car, the demand for gasoline will rise and the supply must keep up. The interface between the suppliers of gasoline and the consumer is the gas station with daily changing prices for a gallon of gasoline. The variance of prices will either drive consumers away or bring them in, especially during peak travel seasons like summer and winter. The technological advancements of fuel efficient vehicles are a major competitor against gasoline, and with the specific engines becoming more popular ever year, the dependency on gasoline might weaken over the next few decades. Still, as for the present time gas stations are a necessity and with the current drop in gas prices the opening of two gas stations should have a stable flow of consumers leading to some profits after initial start-up
costs.
References
Biery, M.E. (2014). Why Gas Station Owners May Be Smiling. Forbes. http://www.forbes.com/sites/sageworks/2014/01/21/profit-margins-at-gasoline-stations-have-increased/
Espey, M. (1996). Explaining the variation in elasticity estimates of gasoline demand in the United States: A meta-analysis, The Energy Journal, 17(3): 49-60
Glenn, R., Anthony Patrick. (2012). Economics, 4th Edition.
Hughes, J. E., Knittel, C. R., & Sperling, D. (2008). Evidence of a Shift in the Short-Run Price Elasticity of Gasoline Demand. Energy Journal, 29(1), 113-134.
How much tax do we pay on a gallon of gasoline and diesel fuel? U.S. Energy Information Administration. January 20, 2015. http://www.eia.gov/tools/faqs/faq.cfm?id=10&t=10
KALEN, S. (2012). THIRST FOR OIL AND THE KEYSTONE XL PIPELINE. Creighton Law Review, 46(1), 1-25.
New Gilbarco Encore 300 with Monochrome CRIND. Paul & Associates. 2013. http://www.paulandassoc.com/products/gilbarco-encore300/
Petroleum & Other Liquids. U.S. Energy Information Administration. January 22, 2015. http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=pet&s=rwtc&f=m
Polách, J., & Virglerová, Z. (2011). OIL PRICES AND ITS DEPENDENCE ON OIL RESERVES. Scientific Papers Of The University Of Pardubice. Series D, Faculty Of Economics & Administration, 16(22), 155-164.
Reasons to Break America’s Addiction to Foreign Oil. Economics & Statistics Administration. http://www.esa.doc.gov/Blog/2011/05/18/three-more-reasons-if-we-needed-more-break-americas-addiction-foreign-oil June 29, 2011.
Retail Fuel Report and Data for California. Energy Almanac. 2012. http://energyalmanac.ca.gov/gasoline/piira_retail_survey.html
SLADE, E. (2012). THE KEYSTONE PIPELINE ADDITION: ASSESSING THE POTENTIAL BENEFITS OF REDUCED GASOLINE PRICES AND INCREASED NATIONAL SECURITY. Creighton Law Review, 46(1), 27-60.
Staycation Definition. Investopedia. http://www.investopedia.com/terms/s/staycation.asp Retrieved January 22, 2015.
Tesla Motors. Tesla. 2015 http://my.teslamotors.com/goelectric#range Retrieved January 22, 2015
Toyota Prius. Toyota. 2015. http://www.toyota.com/prius/ Retrieved January 22, 2015