Answers for Econ protected time essay (W4)

a) Account for the surge in fuel price. [12]

Fuel price is determined by forces of demand and supply. Surge in fuel price is due to a combination of both demand and supply side factors.

Demand side factor:

- Economic boom in major economies

= Increase in demand for oil in developing countries, paricularly in Asia, the Middle East and Latin America

> Increase in demand for oil as source of energy to power industries

> Rising income due to economic growth has increased demand for private transport. This has lead to increasing demand for petrol which is derived from oil and hence increasing demand for oil.

- Expectation of future increase in price oil (due to speculation)

- Commodities market have become increasingly attractive for investors seeking to diversify their portfolio and who are looking for better returns than stocks, bonds and currencies. (Slump in stock market and low interest rate)

- The weak US currency which makes dollar- priced crude oil cheaper for buyers using other currencies and tend to encourage demand.

Supply side factors:

- Depletion of oil resources

- Reluctance of OPEC (control 40% of world supply) to increase production (restrict supply in order to maintain or raise prices)

- Disruption of oil supply in major oil exporting countries

= War /political tension E.g Nigeria

= Industrial strike action (by labour), causing refineries to shut down/stop production E.g Britain

=Natural calamities affecting oil production/exploration/refinery

- Lack of major oil discoveries

- Shortage of refinery capacity

Increase in price of oil largely demand driven. Supply factors exacerbated increase. Increase in demand for oil is greater than fall in supply.

Reason for increase in price of oil to be more significant

- Demand for oil is price inelastic

= Lack of availability of close substitute for oil

= Important input for production

- Supply of oil is price inelastic

= Little/No excess capacity to increase oil production i.e small/no pool of unemployed labour and unused machinery due to insufficient investment in exploration and refining activities.

- Small stock of oil inventories