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Petroleum Pricing - Essay Example

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Petroleum Pricing

Below we will analyze this phenomenon in light of both price elasticity of demand and also the cross price elasticity of demand.
Price elasticity of demand is the measure of percentage change in prices on the percentage change in quantity demanded of a certain product. 1 Price Elasticity of demand is a negative ratio as there is a negative relation between price and quantity demanded. In simple terms, common sense suggests that if price of certain product increases then people will tend to buy less of that product.
One of the determinants of the price elasticity of demand is the number and the closeness of substitute products; analyzing the substitutes available for petrol, we have compressed natural gas, bio fuels which include hydrogen gas, liquefied natural gas (LNG) and liquefied petroleum gas (LPG)2 etc. All these can be used for transportation. But the problem that so arises is that these fuels need to be compatible with the cars that run on the road and the particular country's government and other regulations should also be supporting the alternative forms of transport. ...
ted with converting to the alternative forms of fuel efficient energy; presence of substitutes is there and they may be close but the usage process involves fixed cost that is quite difficult to bear.

Another determinant of price elasticity of demand is the proportion of income that is spent on the good; a major proportion of income is generally spent on the transportation be it refilling of the own car or the use of the money to use any public modes of transport. Hence we see that there are many demonstrations and revolts when the prices of oil increase. Generally, what happens is that as the prices increase and if the proportion of income spent on the good is more then we are forced to cut on the consumption, but as far as usage of fuel is concerned it is a basic necessity and no on can easily cut back on consumption; but still, this determinant also has its affect on the demand.

Lastly, we have time period as the determinant of the price elasticity; the longer the time period after the price change, greater is the impact of the price change on demand. In case of petrol price increases, this is very much a dominant factor as people get more time to switch, manufacturers of car and change in people's psyche takes more time to accept the trend the more they are likely to shift towards alternative fuels.

TO conclude, we can say that price elasticity of demand of petrol is relatively low in the short run but quite high as we talk about the long run.3

Cross price elasticity of demand and effect of increasing oil prices

Cross price elasticity of demand measures the response of quantity of one good demanded to a change in the price of another good.4 Cross price elasticity unlike price elasticity is either negative or positive. If it is positive, it indicates that ...Show more

Summary

Elasticity in simple terms is defined as the change in one variable due to the change in another. Since, when we operate in a system it is not unusual that things affect one another. Therefore, in economics we see that simple demand and supply of products are affected by prices, change in prices of other goods etc.
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