Is the Government to Blame for Higher Petrol Prices?

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CONTENTS PAGE                                                                PAGE NO

Introduction                                                                        2

Economic Theories                                                                3 - 6

Data Collected                                                                        7

Presentation of Findings                                                        8 - 13

Evaluation and Conclusion                                                        14 - 15

Bibliography                                                                        16


In September 2005 the UK experienced unprecedentedly high petrol prices at filling stations throughout the country. In rural Wales the psychologically important £1/litre was breached for the very first time. What I wish to investigate is what is causing prices to be so high at the pumps at this particular time and why petrol prices are rising faster than the rate of inflation. In 2000 there were widespread protests to the level of government taxation placed upon petrol as it was felt to be excessive and unfair, similar smaller protests occurred this year also. Government Taxation is a major determinant on the price of petrol however there are other factors which determine the price of petrol. The price of petrol is made up of 4 components. The Fuel Duty imposed upon it, the Value Added Tax imposed upon it, the amount the product cost and the retailer/deliverer’s overheads.

As we all know the two taxes are determined by the government, the product’s price is determined by the price of oil and the retailer’s/deliverer’s overheads by the costs of production associated with selling the oil. I will therefore need to investigate the rate of taxation used by the government on petrol and what determines the price of Crude Oil being the main component of Petrol. Crude Oil is a derived Demand as it is useless as it is it is made into useful products like petrol. I will investigate the Retailer/Deliverer overheads differences between different suppliers and different companies will charge different prices for petrol.

My investigation to cover both the short and longer term history of petrol prices and I will try to used historical data and economic theories to try and establish why Petrol Prices are rising on a general long term trend. I will look in the short term to see why in this moment in time prices seem to be at this high levels and questioning are these prices high enough to reflect the true cost of Petrol? Petrol prices are often cited in newspapers and TV and my aim is to look behind the headlines and try to establish the economic basis behind these.

ECONOMIC THEORIES (Applicable to Petrol Prices)

Price Elasticity of Demand for Oil (Product)

Refers to the responsiveness of quantity demanded to a change in price. If quantity demanded changes by a smaller proportion than the price the good is said to be “price inelastic”. If quantity demanded changes by a larger proportion than the price change then the good is said to be “price elastic”.

Goods where prices and demand change by the same proportion are called “price unitary”. I believe oil demand to be price inelastic in the short run i.e. PED<1 (diagram A) with demand becoming increasingly price elastic in the long run i.e. PED>1 (diagram B).

My reasoning behind this is because Oil is such an essential good for many different production processes where there are no alternatives e.g. Plastics, Medicines and Fertilisers that the Oil is bought no matter what price it is. It is also the main method of fuelling transportation globally, being used by aeroplanes, cars, trains and ships along with being used in many power stations. However over the long run as oil begins to run out being a finite resource and the oil price becomes unsustainably high, alternatives to Petrol are likely to be used e.g. Solar Power to power our vehicles and Wind Power and to be used in power stations.

Price Elasticity of Supply of Oil (Product)

Refers to the responsiveness of quantity supplied to a change in price. If quantity supplied changes by a smaller proportion than the price the good is said to be “price inelastic”. If quantity supplied changes by a larger proportion than the price change then the good is said to be “price elastic”. Goods where prices and supply change by the same proportion are called “price unitary”.

I believe that if Oil supply was unrestricted by OPEC supply would be more Price Elastic than it is now when OPEC control such a large portion of the world’s crude oil supplies. As Oil Prices rose the incentive to sell more, extract more and search for more oil would increase causing supply to expand (diagram C). However as OPEC acts like a cartel it chooses to restrict Oil supply to keep prices high (diagram D) making the supply of Oil highly Price Inelastic. This means that if Prices were to rise supply would only increase marginally if at all.

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In the extreme Long Run Oil will run out being a finite resource (diagram E) and at LRAS any increases in demand would merely lead to higher prices as output would be unable to expand. This would be when we are forced to use alternatives to Petrol.

Externalities (Taxation Policy)

Externalities are a cost or benefit received by third parties not directly involved in the production or consumption of a product. Negative Externalities produced from producing and consuming petrol include air pollution, global warming and ill effects to people’s health. The Government often cites the main reason for taxing petrol ...

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