Price of oil increased significantly during 1970s due to two major events. First the oil embargo from Arab countries in the Middle East to Western countries following their support for Israel during the Yom Kippur War (1973) and second the Iranian Revolution in 1979. Oil is refined to produce gasoline for cars and as the price of oil increased during 70s, the cost of producing gasoline went up as well. These two events during 70s are commonly known as "Oil Shocks". More generally, the "Oil Shocks" are examples of what are termed negative supply shocks that you will learn in your macroeconomics courses. a. Illustrate the effect of the "Oil Shocks" on the market for gas by using supply and demand curves. (Recall oil is an input used to produce gas.) Do the oil shocks produce a surplus or shortage for gas?
b. In the face of sky-rocketing gas prices, Nixon administration in 1973 imposed a maximum price on gas. (The depressed pump prices imposed during 1973 went through several iterations during 80s.) The price ceiling on gas brought about long lines at gas stations and a shortage of gas during 70s. Now illustrate this binding price ceiling on gas in your plot from part a.
c. Oil is a curious commodity in that its price affects the cost of transportation of people and other commodities. Hence when there is an "oil Shock, it doesn't only increase the price of gas, but through the price of gas it also increases the price of transporting everything. Since the great majority of goods in a modern economy are not consumed at the location they are produced and have to transported, "Oil Shocks" increased the cost of transporting everything in 70s, creating higher costs for producers. Now again consider the market for oranges. Illustrate what happened to the market for oranges in the US during 70s following the "Oil Shocks". What happened to the price of oranges?
BONUS TRIVIA: US doesn't only consume oil but also produces and exports it (ie: sells its oil to foreign countries). In 1977, the Carter administration imposed a ban on oil exports from the US to foreign countries, because they were concerned with the increasing price of oil. This ban was only recently lifted in 2015 after almost 40 years thanks to the shale oil revolution here in the United States.