The effect of an increase in gas prices on the supply of and demand for gas and electricity, in the short and long term
ADRIAN DANIELS INTRO TO ECONOMIC THEORY STUDENT NO: 0800 5892
REFERENCES PAGE 9
The Economist (The Economist, 2008) has reported that energy prices are getting 'higher and higher'. This is especially for Electricity and Gas. Consider an effect of gas prices increasing, being that people will switch to alternative energy providers. For example, from the United Kingdom's number one Gas and Electricity provider 'British Gas', to ‘EDF’. This may only apply to people involved in the lower end of the national wealth distribution. People who form the higher end of the national wealth distribution may not even realise the change in price that has been made to the gas and electricity prices. For instance, the ‘1% of the United Kingdom’s population who own 21% of the nation’s wealth’ (Inland Revenue, 2006) .Thus they are very unlikely to react towards this change. On the other hand, people who form the lower end of the national wealth distribution (such as pensioners) will notice this increase in gas and electricity costs. Their income is significantly lower than those in the higher end of the wealth distribution, so they have to monitor their household income and budget with their spending. As a result, Families may have to switch utility companies if prices charged by 'British Gas' do not fit their household budget for instance. This is so that they can afford to cover other costs like mortgages and food. The individual's income and the price of the goods or services are determinants of an individual's demand for a good or service. Therefore the demand for gas and electricity will fall. This is illustrated below:
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Shift in demand for Gas and Electricity
Consequently, people may use substitutes to gas and electricity. They may revert to how things were done traditionally in the past, when gas and electricity was not even invented. So they may use candles and wood as substitutes. Electricity and Gas are not necessities. They are not essential for survival. The less unfortunate people residing in rural areas in 'Third World' countries have to make do without electricity and gas. They make use of candles as a light source. They use wood as a heat source, which is also used to provide heat to cook their food. Furthermore, for electrical devices, batteries can act as a power source. Therefore, the increase in gas and electricity prices may lead to an increase in the demand and supply of candles, batteries and wood. This is illustrated by the diagram shown below:
Shift in demand for candles, batteries Shift in supply for candles, and wood batteries and wood
However, this may only be a temporary effect. The reason being for people switching over to cheaper utility companies is the size of their income. People would be more likely to afford rises in gas and electricity bills if they were to get a pay rise or promotion. Furthermore, with the world's economic conditions in danger because of the credit crunch situation, goods and services are getting progressively expensive. As a result, Families have less money for their weekly expenditure. So considering the worst scenario, gradually everyone will stop using Gas and electricity because of the rising costs of goods and services. This will put utility companies including Uswitch on thin ice. They have chosen to supply these utility services because the benefits of providing them outweigh the costs it takes to produce these services. Therefore, it will not make sense for these companies to continue providing their services. In the long term, the increase in gas and electricity prices could lead to the failure of utility companies like British Gas. The production costs of the utility companies outweigh their cash flow income, and thus are unable to keep the business alive. This is because the supply of these services exceeds the demand for them. This is as illustrated in the diagrams below:
Excess Supply of Gas
In contrast, if the price of gas and electricity substitutes (i.e. Candles, wood and batteries) was to increase dramatically, there would be a huge shift in demand and supply. So if the price for a substitute increases, such as batteries over electricity, then the original demand curve will shift right. This is illustrated by the diagram below:
A Shift to the Right for the original demand curve in terms of the prices of Substitutes increasing
Change in taste can be a long term effect of the increase in gas and electricity prices on the supply and demand curve. Property owners who switch on their television sets will be aware that climate change is happening. Channels like the 'BBC' has televised that climate change can endanger the world in various ways. For instance, BBC News (BBC News, 2008) have reported that 'Climate change could be the "last straw" for rare woodlands in the far north of Scotland already damaged by overgrazing animals.' As a result, utility companies may have responded to climate change by increasing their prices. These high prices can put customers off purchasing their services. So the customers respond by cutting down on their electricity and gas usage to help the environment, or stop using these utilities altogether to reduce their carbon footprint. Again, like in the last section, we see a shift in the supply and demand curve, to the left. This is illustrated in the diagram as follows:
A Shift to the left in terms of quantity and demand for electricity and gas
Harry Wallop's report (Wallop, 2008) suggests that environmental factors have an influence in the effect of the increase of gas and electricity costs on the supply and demand curve. Weather has a big impact on these utility costs. For instance, the demand for gas and electricity in the winter season exceeds the demand for gas and electricity in the summer season. Therefore gas and electricity costs are higher during this period. Property owners in the lower distribution are forced to come up with the financial resources to be able to afford the utility costs during winter. They may have to see this as an opportunity cost. Warmth in shelters is essential for survival. Utility companies take advantage of this as a result. We are limited to spend a certain amount. Thus we must sacrifice having less of something to be able to afford extra heating, for instance, saving money by using less electricity for more central heating in our homes. This theory is illustrated in the diagram below:
Less electricity, more heating
More electricity, Less Heating
(BBC News, 2008)
(Inland Revenue, 2006)
(The Economist, 2008)
- The Economist.2008. Energy Prices. Higher still Higher, <>, accessed 10th January 2008.
- National Statistics Online.2006.Society. Share of the wealth, <>, accessed 8th May 2006.
- BBC News.2008.UK News. Climate change threat to woodland, <>, accessed 18th November 2008.
- Wallop, H.2008. Personal Finance. Gas and electricity bills could climb yet higher this winter, report warns, <>, accessed 26th September 2008.