The Chancellor of the Exchequer has decided to raise the duties payable on petrol. Assess the likely impact of this policy on the markets, which arelikely to be affected.

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Ivor Lloyd-Rees

The Chancellor of the Exchequer has decided to raise the duties payable on petrol. Assess the likely impact of this policy on the markets, which are likely to be affected.

           Taxes can be divided into those that are direct or indirect. By direct we mean those taxes levied on the income, wealth, profits of persons and companies. The personal income tax is the best example. The duty payable on petrol i.e. the excise duty is indirect, as it is a tax levied on expenditure on goods and services. Ultimately, however, the burden of taxation is borne by the individuals. It is still a useful way of classifying the taxes and one that I will continue using as ‘direct’ taxes reduces money income; indirect taxes raise prices.

        

VAT is an indirect tax, however, it is not specific. Excise duty is. What this indicates is that the amount of tax levied does “not change with the value of the goods but the amount of volume of goods purchased” (Anderton 1991 (p 61). That is the amount of duty on a litre of fuel will be the same regardless of whether a person wants one litre or 5000 litres of petrol. Tobacco and alcohol also come under this heading. The implementation of a specific tax on petrol has an effect on the supply curve, it will be shifted upwards in parallel. This is important, as the amount of tax or excise duty is the same at all levels of price:

Figure 1 shows that people are paying more for the same amount of petrol. In this example 75p a litre was paid for petrol in October but 81p a litre in November. Basic economic theory suggests that a price increase (in this case due to excise duty) will provoke a decrease in demand:

A study of this diagram will reveal that it is fundamentally flawed for a discussion of petrol, for one simple reason, in this modern age petrol is a necessity, not a minor vice like alcohol or tobacco. Driving is not regarded as a vice but heavy taxation is still applied by the Chancellor as the price is demand inelastic, that is, “a change in price (due to increased duty) causes a proportionally smaller change in the quantity demanded”. (Sloman and Sutcliffe 1998 (p 72). When the recent fuel crisis was at its height people did not stop driving, they continued if they could find petrol. The demand was still high even if the supply was limited.  

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        A good example of how taxes can influence the face of markets is demonstrated by remembering the 1988 budget when the excise duty on a gallon of 4 star petrol increased by 10p, unleaded was left unchanged. This was the start of a price difference between the two types of petrol of 10p. Over 12 months sales of leaded petrol fell by ¼.

The consumer bears the 10p price difference from £1.90 to £2.00, as the short-term supply curve for petrol is perfectly elastic. Unleaded petrol is a very ...

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