The price of road fuel is falling. Petrol and diesel prices in the UK are now at their lowest level since February 2011. The average pump price for a litre of unleaded petrol has fallen to 130.44p in November – down nearly 8p per litre since September.
According to the AA, the reduction in price equates to a fall in the average monthly expenditure on petrol of a two-car family of £14.49 – down from £252.54 to £238.05. This saving can be used for spending on other things and can thus help to boost real aggregate demand. The fall in price has also helped to reduce inflation.
But will lower fuel prices lead to a rise in fuel consumption? In other words, will some of the savings people make when filling up be used for extra journeys? If so, how much extra will people consume? This, of course depends on the price elasticity of demand.
The following articles explain why the price of road fuel has fallen and look at its consequences.
Webcast
Good news for motorists as fuel prices fall in the East ITN (22/11/13)
Articles
November fuel price update Automobile Association (22/11/13)
Finally there is good news for motorists as petrol prices hit lowest level since 2011 The Telegraph, Steve Hawkes (22/11/13)
Petrol prices fall to lowest level for almost three years as strong pound gives motorists relief on the forecourt This is Money, Lee Boyce (22/11/13)
Falling petrol prices boost motorists The Guardian (22/11/13)
Data
Weekly road fuel prices Department of Energy & Climate Change
Europe Brent Spot Price US Energy Information Administration
Spot exchange rate, US $ into Sterling Bank of England
Questions
- Why have the prices of petrol and diesel fallen?
- Illustrate the fall in price of road fuel on a demand and supply diagram.
- How does the size of the fall in price depend on the price elasticity of demand for road fuel?
- If a fall in price results in a fall in expenditure on road fuel, what does this tell us about the price elasticity of demand?
- Why may the price elasticity of demand for road fuel be more elastic in the long run than in the short run?
- If a motorist decides to spend a fixed amount of money each week on petrol, irrespective of the price, what is that person’s price elasticity of demand?
- Using the links to data above, find out what happened to the dollar price of sterling and the Brent crude oil price between September and November 2013.
- How do changes in the exchange rate of the dollar to the pound influence the price of road fuel?
- If the price of oil fell by x per cent, would you expect the price of road fuel to fall by more or less than x per cent? Explain.
- Why do petrol prices vary significantly from one location to another?
UK Supermarkets: a prime example of an oligopoly. This industry is highly competitive and over the past decade, but particularly since the onset of the credit crunch, price wars have been a constant feature of this market. You could barely watch a full programme on commercial TV without seeing one of the big supermarkets advertising that their prices were lower than everyone else’s! So, despite oligopoly being towards the ‘least competitive’ end of the market structure spectrum, this is an example of just how competitive the market can actually be.
With household incomes being squeezed, in particular by another oligopolistic industry (energy) and with the ‘middle market’ being pinched by higher-end retailers and budget retailers, the supermarket sector is facing uncertain times. Asda’s sales growth has continued to slow and in response, the giant supermarket chain will be launching a £1 billion price-cutting campaign. Tesco is the market leader, but Sainsbury’s and Asda have been battling over the second spot. One of Asda’s selling points is its low prices. Perhaps not as low as Aldi and Lidl, but this new pricing strategy will aim to bring its prices further below Tesco, Sainsbury’s and Morrisons and
close the gap with the two big discount supermarkets. As Andy Clarke, Asda’s Chief Executive, said:
We regard ourselves as the UK’s leading value retailer and it is against this backdrop that I have today set out our strategic priorities which will improve, extend and expand the business over the next five years.
So, what will be the impact of lower prices? It appears as though Asda is marketing itself towards the budget end of the pricing spectrum, perhaps aiming to become fiercer competitors with Aldi and Lidl and let Tesco and Sainsbury’s do battle with the higher-end retailers, such as Waitrose and Marks and Spencer. Lower prices should cause a substitution effects towards Asda’s products, as many of them will have relatively price elastic demand. If the other supermarkets don’t respond, this should lead to sales growth. However, the key to an oligopoly is interdependence: the actions of one firm will affect all other firms in the market. The implications then, are that Tesco may react to this pricing strategy by engaging in its own price cuts, especially as the Christmas period approaches. The characteristic of interdependence was evident in the aftermath of Asda’s announcement when shares in Tesco and Morrisons both fell, showing how the markets were responding.
Of course, there are many other factors that affect a consumer’s decision as to whether to shop at Asda, Tesco or any other big supermarket. In the area where I live, we have a Tesco and a Morrisons (a few years ago, we had neither!). I don’t shop at Asda, as the nearest branch is over 30 miles away – even if prices were significantly lower, it would be more expensive to get there and back and a lot less convenient. For others, it may be loyalty and not just of the ‘I’ve shopped there all my life’ kind! For some, clubcard vouchers from Tesco may be preferred to Asda’s offerings and thus tiny price differences between the supermarkets may have little effect on a consumer’s decision as to where to shop. Many products at supermarkets are relatively cheap and thus as the proportion of our income that we spend on these goods is pretty low, any change in price doesn’t cause much of an effect on our demand.
It’s not just a pricing strategy where money is being invested by Asda. More investment will be going into their online services and more stores will be created, kin particular in London and the South East where their presence is low, but demand appears to be high. Improving ‘product quality, style and design’ will also be on the agenda, all with the aim of boosting sales growth and securing its position as the second largest retailer in the sector, perhaps with a long term aim of one day overtaking Tesco. The following articles consider the supermarket battleground.
Supermarket battle heats up as Asda announces £1bn price-cutting plan The Telegraph, Graham Ruddick (14/11/13)
Sainsbury’s profits make it second biggest supermarket BBC News (13/11/13)
Asda to launch £1bn price-cut plan AOL, Press Association (15/11/13)
Asda takes fight to rivals with £1bn investment plan The Guardian, Angela Monaghan (14/11/13)
UK’s Asda promises £1 billion investment in price cuts Reuters (14/11/13)
Asda makes bid to woo shoppers with vow of five-year £1billion price war after it was overtaken in market share by Sainsbury’s Mail Online, Sean Poulter (15/11/13)
Sainsbury’s overtakes Asda on demand for its premium lines Independent, Simon Neville (14/11/13)
Asda to put £1bn into lowering prices over five years The Grocer, Thomas Hobbs (14/11/13)
Wal-Mart posts $3.7bn quarterly income BBC News (14/11/13)
Questions
- What are the key characteristics of an oligopoly?
- What is meant by a price war? Who benefits?
- How important is the concept of price elasticity of demand when deciding whether or not to cut the price of a range of products?
- Why is the proportion of income spent on a good a key determinant of the elasticity of demand of a product?
- How can market share be calculated?
- Many suggest that the ‘middle market’ of the supermarket sector is slowly disappearing. Why is this?
- How effective will Asda’s price cutting strategy be? Which factors will determine its effectiveness?
The model of demand and supply is one of the first diagrams that any student of Economics will see and it’s a very important model. We can apply it to a multitude of markets and understand how market prices for products and services are determined. One such market is that of wine, where a recent report suggests that wine is in short supply. Bad news for everyone!
The price of wine is set by the interact of demand and supply. As with any market, numerous factors will affect how much wine is demanded at any price. Since 1996, global consumption of wine has been on the increase: for many, wine is a luxury good and thus as income rises, so does consumption. With the emergence of markets, such as China and subsequent income growth, consumption has risen. Furthermore, tastes have changed such that wine is becoming an increasingly desirable drink. So, this has all led to the demand curve shifting to the right.
However, at the same time, the supply of wine has been falling, largely the result of ‘ongoing vine pull and poor weather’ across Europe. European production has fallen by around 10% over the past year and although production in other countries has been rising, overall production is still not sufficient to match the growth in demand.
So, what’s the result of this high growth in demand combined with the decline in supply? A shortage of wine. A report by analysts at Morgan Stanley suggests that the global wine shortage was some 300m cases in 2012. But, more importantly what is the effect of this shortage? When demand for a product exceeds the supply, the market mechanism will push up the price. As stocks of wine continue to be depleted and consumption of wine keeps rising, the only outcome is a rise in the price of a bottle and a crate of wine.
Concerns are also being raised about the future of prices of some of our other favourite luxury products, such as chocolate, goats cheese and olives. In each case, it’s all about demand and supply and how these curves interact with each other. The following articles consider the prices of some of these products.
Wine shortage: the top five wines to drink – before they run out The Telegraph, Susy Atkins (30/10/13)
World faces global wine shortage – report BBC News (30/10/13)
Luxury food shortage scares – should we believe the warnings? The Guardian, Emine Saner (5/11/13)
The global wine ‘shortage’ Napa Valley, Dan Berger (8/11/13)
Global Shortage of wine beckons Independent, Felicitiy Morse (30/10/13)
The global wine shortage is about to get worse (if you like Bordeaux) TIME World, David Stout (6/11/13)
Have no fears about a world wine shortage – the glass is still half fulll The Telegraph, Victoria Moore (31/10/13)
Drink it while you can, as study points to looming wine shortage Associated Press (31/10/13)
Don’t waste a drop! Wine prices to rise as demand grows Mail Online, Amie Keeley (31/10/13)
Questions
- Use a demand and supply diagram to illustrate how the market price for wine (or any other product) is determined.
- Why does the demand curve for wine slope downwards and the supply curve of wine slope upwards?
- Which factors will affect (a) the demand and (b) the supply of wine?
- One the diagram you drew in question, illustrate a shortage of wine. How will the price mechanism work to restore equilibrium?
- Why does the Morgan Stanley report suggest that a wine shortage might emerge?
- What suggestions are there that there is no wine shortage?
A bumper harvest should be good news for farmers – but not if it drives down prices. This is the position facing many Australian farmers. After a relatively wet summer a year ago and a mild winter this year, crop yields have soared. But the prices farmers can get in wholesale markets have been so low that many have resorted to setting up their own farm shops or selling in farmers’ markets or from the backs of ‘utes’ (utility vehicles, i.e. pickup trucks) or at roadside stalls.
And the supply problem is not just one of increased domestic supply: cheap food imports, often of inferior quality, have been flooding into Australia. Increasing food exports, 
especially to Asia, would help Australian farmers, but here again there is competition in these markets from other countries.
The problem of increased Australian supply is even more serious for Australian farmers in areas where harvests have not been so good. Australia is a huge country and conditions, although generally favourable this year, have been poor in some areas. Here farmers face the double disaster of low output and low prices.
Australian dairy farmers too are facing problems of falling prices. Price deregulation and the monopsony power of supermarkets have driven down 
the price of milk and other dairy products. Since deregulation in 2000, the number of dairy farms has halved, as many smaller family farms go out of business and larger ‘industrial-scale’ farms grow.
So are there any solutions? The BBC article looks at things being done in Tasmania to help small farmers, but questions whether small farmers have much of a future more generally in Australia?
Articles
Australia’s small farmers struggling with low prices BBC News, Phil Mercer (31/10/13)
Commodity prices edge lower in October Sky News Australia (1/11/13)
Low prices spoil perfect season for Australian farmers ABC News, Eric Tlozek and Courtney Wilson (18/9/13)
Agri-businesses taking over the farm The Guardian (Australia) (6/11/13)
Data
Commodity prices Index Mundi
Agriculture in Australia Wikipedia
Farm inputs & costs Dairy Australia
Questions
- How does the fallacy of composition relate to the ‘problem’ of good harvests?
- How price elastic is the demand for specific crops likely to be? Why may individual farmers face an elasticity of demand close to infinity?
- Illustrate the problem for small farmers in Australia with a demand and supply diagram.
- Is there any way in which farmers, either individually or collectively, can make their demand less elastic?
- Comment on the following statement by a sugar cane farmer: “We’ve got that much money tied up (in the business) we just can’t walk away”. Under what circumstances would it make sense to ‘walk away’?
- How does the monopsony power of supermarkets influence the prices farmers receive?
- Discuss ways in which the federal government in Australia could support farmers.
Your favourite chocolate bar or your drink of hot chocolate could soon be much dearer. Since March, the price of cocoa has risen by 34% and much of this increase remains to be passed on to the consumer. The price of cocoa butter is up 70% since the beginning of the year.
On the demand side, sales of luxury cocoa-rich chocolate and hot chocolate have been rising and chocolate manufacturers, with relatively low forward purchases of cocoa, are likely to have to buy more in spot markets. What is more, there is growing speculative demand as traders anticipate higher prices to come.
On the supply side, dry weather in West Africa, where 70% of cocoa beans are produced, has led to a fall in output. Estimates suggest that cocoa production in the 12 months to
end-September 2013 will be 2.7% down on the previous 12 months. Supply is expected to be 60,000 tonnes less than demand, resulting in a fall in stocks from 1,833,000 to 1,773,000.
The following articles look at the ‘crisis’ for chocoholics and at the market conditions that lie behind it.
Articles
Craving for a chocolate fix? Prepare to pay more Reuters, Lewa Pardomuan and Marcy Nicholson (15/9/13)
Hot chocolate demand sends cocoa prices soaring Financial Times, Emiko Terazono (15/10/13)
Price of chocolate ‘to triple’ The Telegraph (8/10/13)
Paying more for chocolate? You will be CNN Money, Alanna Petroff (14/10/13)
Chocolate Prices Soar in Dark Turn The Wall Street Journal, Leslie Josephs and Neena Rai (22/9/13)
Chocolate prices could increase as cocoa costs soar BBC News, Nigel Cassidy (21/10/13)
… and on a lighter note: Rising Prices Signal A ‘Devastating’ Global Chocolate Crisis: Should Government Act To Save Us? Forbes, Doug Bandow (14/10/13)
Data
Cocoa beans: monthly price Index Mundi
ICCO daily prices of cocoa beans International Cocoa Organization (click on calendar to select month)
Production of cocoa beans International Cocoa Organization (click on Statistical Data links in right hand panel
Monthly review of the market International Cocoa Organization
Questions
- What happened to cocoa prices from January 2009 to March 2013? Explain this movement in prices.
- Why have cocoa prices risen so much since March 2013? Illustrate your analysis with a supply and demand diagram.
- If the demand for luxury chocolate fluctuates considerably with the state of the business cycle, what does this suggest about the income elasticity of demand for luxury chocolate?
- How would you establish whether or not cheap chocolate is an inferior good?
- If cocoa prices rise by 34%, what determines the percentage by which a bar of chocolate will rise?
- What determines the difference between cocoa futures and spot prices?
- How realistically could government intervention improve the lot of chocoholics?
The price of road fuel is falling. Petrol and diesel prices in the UK are now at their lowest level since February 2011. The average pump price for a litre of unleaded petrol has fallen to 130.44p in November – down nearly 8p per litre since September.
