From early January to late February 2013, the average pump price of petrol in the UK rose by over 6p per litre – a rise of 4.7% in just seven weeks. There have also been substantial rises in the price of diesel.
The higher prices reflect a rise in the dollar wholesale price of oil and a depreciation in the pound. From 2 January to 21 February the pound fell from $1.63 to $1.53 – a depreciation of 6.1% (see). Crude oil prices (in dollars) rose by just under 7% over this period. With oil imports priced in dollars, a weaker pound pushes up the price of oil in the UK. The price has then been pushed up even higher by speculation, fuelled by the belief that prices have further to rise.
The higher price of road fuel, plus the general squeeze on living standards from the recession, with prices rising faster than wages, has caused a reduction in the consumption of road fuel. Petrol sales have fallen to their lowest level for 23 years. Sales in January 2013 were 99m litres down on the previous month’s sales of 1564m litres (a fall of 6.3%).
Not surprisingly motorists’ groups have called for a reduction in fuel taxes to ease the burden on motorists. They also argue that this will help to drive recovery in the economy by leaving people with more money in their pockets.
Equally not surprisingly, those concerned about the environment have welcomed the reduction in traffic, as have some motorists who like the quieter roads, allowing journey times to be cut, with resulting reductions in fuel consumption per mile.
The following videos and articles discuss the causes of the most recent fuel price rises and also examine the responsiveness of demand to these higher prices and to the reductions in real incomes.
Webcasts
Rising petrol prices are ‘forcing drivers off the road’ BBC News, Richard Westcott (22/2/13)
Fuel prices ‘forcing drivers off road’ – AA BBC News (22/2/13)
Fuel Prices Head For Highest Level Ever Sky News (22/2/13)
Commodities Next Week: Fuel Prices Hit Fresh 2013 Highs CNBC (22/2/13)
Ministers to blame for high fuel prices, says competition watchdog The Telegraph, Peter Dominiczak (30/1/13)
Articles
Petrol price surge adds 6.24p to a litre in a month The Guardian (22/2/13)
Petrol prices set for record highs as speculators and weak pound drive up pump costs again This is Money (22/2/13)
How are motorists saving fuel? NNC Magazine, Tom Geoghegan (9/3/11)
AA Report
Fuel Price Report (February 2013)
Data
Weekly road fuel prices Department of Energy and Climate Change
Energy consumption in the UK Department of Energy and Climate Change
Oil and oil products: section 3, Energy Trends Department of Energy and Climate Change
Europe Brent Spot Price FOB (Dollars per Barrel) US Energy Information Administration
Crude Oil (petroleum), Price index Monthly Price – Index Number Index Mundi
Questions
- Is it possible to calculate the price elasticity of demand for petrol from the data given? Try making the calculation.
- How important is the ceteris paribus (other things being equal) assumption when calculating the price elasticity of demand for petrol?
- Why is the long-run price elasticity of demand for road fuel likely to different from the short-run price elasticity?
- If wholesale oil prices go up by x%, will prices at the pumps go up by approximately x% or by more or less then x%? Similarly, if the pound depreciates by y% would you expect prices at the pumps go up by approximately y% or by more or less then y%? Explain.
- How has speculation affected fuel prices? Is this effect likely to persist? Explain.
- Under what circumstances would a reduction in road fuel taxes help to drive the recovery? Are such circumstances likely?
- Which groups in society suffer most from higher fuel prices? Is this reflected in their price elasticity of demand and if so why?
- Is a rise in fuel prices above inflation likely to increase or decrease inequality in living standards? Explain.
- Should externalities from fuel consumption and production be taken into account when setting the duty on petrol and diesel and, if so, what would be the implication for prices?
The exchange rate for sterling is determined in much the same way as the price of goods – by the interaction of demand and supply.
When factors change that cause residents abroad to want to hold more or fewer pounds, the demand curve for sterling will shift. If, instead, factors change that cause UK residents to want to buy more or less foreign currency, then the supply curve of sterling will shift. It is these two curves that determine the equilibrium exchange rate of sterling.
There are concerns at the moment that sterling is about to reach a peak, with expectations that the pound will weaken throughout 2013. But is a weakening exchange rate good or bad for the UK?
With lower exchange rates, exports become relatively more competitive. This should lead to an increase in the demand for UK products from abroad. As exports are a component of aggregate demand, any increase in exports will lead to the AD curve shifting to the right and thus help to stimulate a growth in national output. Indeed, throughout the financial crisis, the value of the pound did fall (see chart above: click here for a PowerPoint) and this led to the total value of UK exports increasing significantly. However, the volume of UK exports actually fell. This suggests that whilst UK exporters gained in terms of profitability, they have not seen much of an increase in their overall sales and hence their market share.
Therefore, while UK exporters may gain from a low exchange rate, what does it mean for UK consumers? If a low exchange rate cuts the prices of UK goods abroad, it will do the opposite for the prices of imported goods in the UK. Many goods that UK consumers buy are from abroad and, with a weak pound, foreign prices become relatively higher. This means that the living standards of UK consumers will be adversely affected by a weak pound, as any imported goods buy will now cost more.
It’s not just the UK that is facing questions over its exchange rate. Jean-Claude Junker described the euro as being ‘dangerously high’ and suggested that the strength or over-valuation of the exchange rate was holding the eurozone back from economic recovery. So far the ECB hasn’t done anything to steer its currency, despite many other countries, including Japan and Norway having already taken action to bring their currencies down. Mario Draghi, the ECB’s president, however, said that ‘both the real and the effective exchange rate of the euro are at their long-term average’ and thus the current value of the euro is not a major cause for concern.
So, whatever your view about intervening in the market to steer your currency, there will be winners and losers. Now that countries are so interdependent, any changes in the exchange rate will have huge implications for countries across the world. Perhaps this is why forecasting currency fluctuations can be so challenging. The following articles consider changes in the exchange rate and the impact this might have.
A pounding for sterling in 2013? BBC News, Stephanomics, Stephanie Flanders (17/1/13)
UK drawn into global currency wars as slump deepens Telegraph, Ambrose Evans-Pritchard (16/1/13)
Foreign currency exchange rate predictions for GBP EUR, Forecasts for USD and NZD Currency News, Tim Boyer (15/1/13)
Euro still looking for inspiration, Yen firm Reuters (16/1/13)
Daily summary on USD, EUR, JPY, GBP, AUD, CAD and NZD International Business Times, Roger Baettig (16/1/13)
UK inflation bonds surge on Index as pound falls versus euro Bloomberg, Business News, Lucy Meakin (10/1/13)
Questions
- Which factors will cause an increase in the demand for sterling? Which factors will cause a fall in the supply of sterling?
- In the article by Stephanie Flanders from the BBC, loose monetary policy is mentioned as something which is likely to continue. What does this mean and how will this affect the exchange rate?
- Explain the interest- and exchange-rate transmission mechanisms, using diagrams to help your answer.
- If sterling continues to weaken, how might this affect economic growth in the UK? Will there be any multiplier effect?
- What is the difference between the volume and value of exports? How does this relate to profit margins?
- Why are there suggestions that the euro is over-valued? Should European Finance Ministers be concerned?
- Should governments or central banks intervene in foreign exchange markets?
- If all countries seek to weaken their currencies in order to make their exports more competitive, why is this a zero-sum game?
While the Western world has struggled with economic growth for the past 6 years, emerging economies such as China, Brazil and India have recorded some very high rates of growth. Throughout 2012, there were signs that these economies were not going to be the saviour of the global economy that we all thought. But, as we enter 2013, is it these economies that still hold the hope of the West for more positive figures and better economic times?
The article below from BBC News, in particular, considers the year ahead for the Asian economies and what it might mean for the Western world. Although these countries are by no means safeguarded against the impending approach of the US economy to their fiscal cliff or the ongoing eurozone crisis, they have seemed to be more insulated than the rest of the world. A crucial question to consider is whether this will continue. Furthermore, are the growth levels and policies of a country such as China sustainable? Can it continue to record such high growth rates in the face of the global economic situation?
The Japanese economy has been in serious trouble for a couple of decades, but measures to boost growth for this economy are expected. If these do occur, then western economies may feel some of their positive effects. At present, there is a degree of optimism as we enter the New Year, but how long this will last is anybody’s guess. The following articles consider the year ahead.
Asian economies face regional and global challenges BBC News (1/1/13)
Asia faces hard road ahead China Daily, Haruhiko Kuroda and Changyong Rhee (31/12/12)
Asia to continue rise despite US fiscal cliff Economic Times, Sugata Ghosh (1/1/13)
‘3.6% growth’ for global economy next year China Daily, Alvin Foo (28/12/12)
Asian economies surge ahead despite global slowdown Coast Week, Ding Qilin and Hu Junxin (4/1/13)
Global grind The Economist, Robin Bew (21/11/12)
Questions
- Why have the Asian economies been more insulated to the global economic conditions over the past few years, in comparison with the Western world?
- What challenges will the global economy be facing over the coming year?
- What challenges are the Asian economies facing? How different are they from the challenges you identified in question 3?
- Why is the rate of exchange an important factor for an economy such as Japan?
- What does a low exchange rate for the yen mean for European countries? Is it likely to be seen as a good or bad thing? What about for South Korea? Use a diagram to help you answer this question.
- Why is the economic situation in countries such as China and India so important for the rest of the global economy? Use a diagram to illustrate this.
Trade is generally argued to be good for economic growth, as it allows countries to specialise in those goods in which they have a comparative advantage and thus produce and consume more of all goods in total. However, trade inevitably leads to winners and losers, especially as countries impose tariffs on imports in order to protect domestic industries. This has been the case in the banana industry.
Banana growers in the former European colonies have long been protected by EU tariffs, helping to prevent competition from their Latin American banana growers. But, now things could be about to change. In December 2009, most of the nations concerned reached an agreement in Geneva for tariffs imposed by the EU to be gradually reduced.
The European Union had imposed no duty on bananas from their former colonies, but had imposed tariffs on banana imports from other countries. This meant that those countries now benefiting from zero import duty could sell their bananas for a much lower price, therefore restricting the other nations (who did have to pay an import duty) from competing effectively.
With the World Trade Organisation in attendance, an agreement was signed that puts an end to this trade dispute dating back over 2 decades. The Director General of the WTO, Pascal Lamy said:
‘This is a truly historic moment … After so many twists and turns, these complicated and politically contentious disputes can finally be put to bed. It has taken so long that quite a few people who worked on the cases, both in the Secretariat and in member governments have retired long ago.’
This trade war has been ongoing for many years and this agreement represents a big step in the right direction. With a fairer playing field in this banana market, countries in Latin America will now be much more able to compete with other nations. As economists argue that trade is good, a reduction in protectionist measures should be seen as a good thing and will benefit the countries concerned. The following articles consider this trade resolution.
Banana war ends after 20 years BBC News (8/11/12)
WTO: Historic signing ends 20 years of EU-Latin American banana disputes 4-Traders, WTO (8/11/12)
EU, Latin America nations mark end of ‘banana war’ Fox News (8/11/12)
Banana war ends after 20 years The Telegraph (9/11/12)
Infamous banana dispute ends Sky News (9/11/12)
Questions
- What is comparative advantage and how does it lead to gains from trade?
- How does a tariff help protect a country’s domestic industry?
- Using a diagram, illustrate the effect of a tariff being imposed on banana imports from Latin America. Is there a cost to society of such a policy?
- Now, show what happens when this tariff is removed by the EU. Who benefits and who loses?
- What is the role of the World Trade Organisation?
- How does a tariff affect a country’s ability to compete with other nations?
China has been one of the success stories of the past 20 years, with rapid growth in domestic and export demand. This has created the second largest economy in the world. From 1992 to 2007 annual GDP growth averaged 10.7% and annual export growth averaged 18.9% (see chart).
However, with the credit crunch and ensuing recession, growth rates in China have fallen somewhat. Annual GDP growth has averaged 9.6% and annual export growth has averaged 7.4%. Such growth rates may not seem bad, given that many Western economies have been struggling to achieve any growth, but they have been causing concern for this booming economy.
In its May Outlook, the World Bank forecast China’s growth for the year at 8.2%, but it has since been reduced to 7.8%. A key part of China’s success story has been its export market, but it has been this market that has caused concerns for the mainland economy. In August of this year, its year-on-year export growth was at only 2.7%, but exports last month grew by more than expected, at approximately 7.4%. China has had a consistent trade surplus and according to government figures, this has widened to $27.67 billion in September from $26.66 billion in the previous month.
Recovery in this market will be crucial for the continued success of the economy, as a means of alleviating the fears of a slowdown. This higher growth of exports may be a misleading indicator, perhaps influenced by seasonal factors and thus may not be a sign of what’s to come. Indeed, many analysts have said that they are not convinced that these healthier trade figures will remain. Alistair Thornton, from IHS Global Economics said:
“It’s safe to say we are overshooting the trend here and we expect (the data) to come back in line in the months ahead.”
Citigroup economist, Ding Shaung also confirmed these sentiments:
”The trade data is a positive sign for the Chinese economy … But it remains to be seen whether import and export growth can remain at these levels.”
Part of this pessimism is due to the uncertainty surrounding the growth prospects of its biggest two trading partners – the US and the European Union. Exports to the former have remained relatively high, but exports to the European Union have suffered, falling by over 5.6%. It is likely that weaknesses in the global economy have held back China’s growth prospects in both exports and national output. The Chinese government was aiming for growth of 7.6% in 2012. Not a bad rate you may say, but when compared with growth rates for 2011 (9.3%) and 2010 (10.4%), it does represent a significant fall. The future of the Chinese economy is crucial for the recovery of the world economy, in part as it represents a big demand for imports from other countries, such as the US and Europe. The following articles consider the trade and growth prospects of the world’s second largest economy.
Chinese exports grow faster than expected in September BBC News (14/10/12)
Chinese exports grow faster than expected Financial Times, Patti Waldmeir (14/10/12)
China exports jump, but weaknesses seen ahead The Korea Herald (14/10/12)
China exports rise, hinting at a glimmer of revival New York Times, Keith Bradsher (13/10/12)
China’s trade surplus widens Wall Street Journal, William Kazer (13/10/12)
Chinese surplus widens as exports surge CNN, Paavan Mathemas (13/10/12)
China’s economic slow-down BBC Today Programme, Linda Yueh (18/10/12)
Questions
- What is a trade surplus?
- Which factors have influenced Chinese exports and imports?
- Why is China’s growth rate such an important variable for the UK and other Western economies?
- Why has export growth in China fallen recently? Can you use the same explanation for its lower growth in national output?
- Explain why analysts remain pessimistic about the sustainability of these improved trade figures.
- Using a diagram, illustrate the effect that higher Chinese growth rates will have on GDP in a country such as the UK. Could there be a multiplier effect?
