Edgar wants to review the business of opening a new gas station. He must consider the costs of operating it and the possible revenues he can obtain. This will help to arrive at profits expected. A positive expected profit will imply a thumbs up to the new venture.
The article tells us the gas prices are expected to touch a high of $4. It also states that this high price has forced consumers to squeeze non-gas spending and even cut back on gas consumption. . ‘the hike at the pump is beginning to push drivers off the road’. So we have rising prices and declining consumption. This means lower expenditures by consumers that implies lower revenues for gas station owners.
The article also mentions irregular supplies that can play havoc with short run supplies. But high level of inventories are expected to keep prices lower than expected due to supply problems.
So we have a situation here high prices cause lower revenues due to lower consumption levels. This is seen in left shift in demand for gas. Larger capacities and high inventories will affect supplies- the supply curve may shift to right/ remain stable. Both situations imply lower prices for gas, and more volatile revenues stream.
However the demand for gas is inelastic due to the nature of the good itself. This could imply that revenues do not dip as prices rise. However the prices of gas are very volatile, as seen in the past. This volatility is not a good sign for a stable revenue flow. Also the inelasticity is coming under scrutiny as surveys show people changing their habits and lifestyle to reduce consumption, making demand more elastic than expected. An elastic demand is not good for business.
I would not recommend Edgar to start a new gas station. This is because of high level of uncertainty associated with supply of gas that determines its price as well as changing lifestyles and preferences that make demand more elastic.
The figure shows falling prices with decline in demand and abundant inventories. As lower prices translate into lower revenues when demand is elastic, we expect lower profits as well. The volatility in prices and therefore, revenues in another source of concern.
Lin, Cynthia, and Lea Prince b. “Gasoline Price Volatility and the Elasticity of Demand for Gasoline1.” Department of Agricultural and Resource Economics University of California, Davis, California. Web. 13 Oct. 2014. < http://www.des.ucdavis.edu/faculty/Lin/gas_price_volatility_paper.pdf>.
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