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It’s fuelling anger

Petrol prices have been a bone of contention for some time. With household incomes remaining low and the cost of living rising, the fact that average petrol prices have reached their highest level of more than 1.37p per litre on average will undoubtedly put growing pressure on the approaching budget.

There have already been calls for the Chancellor to reduce fuel duty and with this latest data, the pressure will only mount. The problem is, if fuel duty does fall, so will tax revenues and as one of the Coalition’s key objectives has been to cut the budget deficit, this could pose further problems. Even the calls to cut VAT on fuel will also put a dent in the budget deficit.

Although everyone is undoubtedly feeling the effects of these higher prices, the key thing with petrol is its elasticity of demand. Whether the price of petrol was 0.90p or 1.37p per litre, I continue to buy the same amount. Therefore, for me, the price elasticity of demand for petrol is highly inelastic – at least between those prices. After all, if the price increase above say £3 per litre, I might think twice about driving to work!

So what has been driving this increase in prices? Petrol prices are hugely dependent on the cost of oil and on the demand for any product that uses fuel. With growing demand from countries like India and China, as they continue to develop and grow very quickly; the continuing concerns with Iran’s nuclear programme and the political problems in the Middle East, oil prices have been forced up. The future trend in prices will depend on many factors, not least whether or not there is any change in fuel duty in the 2012 budget and whether something like a regulator is introduced to monitor increases in fuel prices. This is definitely an area to pay close attention to in the coming months.

Petrol prices reach record high Independent, Peter Woodman (3/3/12)
Petrol prices hit record high with further rises expected Guardian, Hilary Osborne (2/3/12)
Appeak to regulate petrol prices This is South Wales (3/3/12)
Plea to slash duty as fuel costs soar to record high Scotsman, Alastair Dalton (3/3/12)
Petrol prices hit record high The Telegraph, David Millward (2/3/12)
Diesel prices predicted to reach 150p as petrol hits new record Guardian, Terry Macalister and Hilary Osborne (2/3/12)

Questions

  1. Which are the factors on the demand side that have pushed up the price of oil and hence petrol and diesel?
  2. What are the supply-side factors that are causing the rising price of fuel?
  3. Use a demand and supply diagram to illustrate the effects you have explained in the first two questions.
  4. In the blog, I mention that my price elasticity of demand is relatively inelastic between 2 given prices. What does this suggest about the shape of my demand curve for petrol? How does this shape affect prices following any change in demand or supply?
  5. Why is petrol a relatively price inelastic product?
  6. There have been calls for the government to cut VAT or reduce fuel duty. What are the arguments for and against these policies?
  7. How effective do you think a petrol price regulator would be?
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