Nova workboard

a blog from young economists at Nova SBE

The importance of Fuel Prices

Over the last weeks there has been a strong debate among worldwide political leaders about the existence of quimical weapons in Syria. Such debate, along with the possibility of military action against Syria, has inflicted serious instability in the fuel prices as a fear of disruption in fuel ´s supply lead to upward pressure on prices.

Fuel is an extremely important raw material for the production of several products. Countries which are strongly dependent on fuel, like Portugal for instance, suffer huge impacts when they come across with high instability in fuel markets as the one arised from the Syria situation. These impacts are mainly due to the lack of reasonable fuel´s substitution production factors, that is, companies have serious difficulties to find other inputs which have the same role in production process as fuel has. Economically speaking, the elasticity of substitution is strongly rigid, which in simpler words means that an increase in price of fuel doesn´t induce a significant change from fuel to another input. Such increase in fuel price doesn´t only have negative impacts to those firms who really need it to produce intermediate production factors (energy, rubbers, plastics, etc.) but also to those firms which need these latter factors to produce final goods and services as electricity, rubber, plastic (etc.) companies increase their prices in order to cover the increase in production costs. In the end, however, it will be the consumers of final goods and services who will basically bear the change in fuel prices as firms of these final goods decide to increase their prices as well ( The share of the burden the consumers pay varies across sectors as the change in prices has previously to take into account the price-elasticity, that is, there might be some sectors where the supply side prefers to bear the large part of the tax due to the an high elasticity).

Political leaders have not much room of manoeuvre to tackle the volatility in fuel prices as they are mostly determined by global supply and demand and the market decides the price. However there are some internal factors, such as local market conditions, government regulation and competion, taxation, which might have some impacts on the final price of fuel. As far as the taxation is concerned, taxes make up a somewhat significant component of the price in a litre of fuel but it varies from product to product as well as from country to country. Although there are some specific characteristics of the local markets which may determine different fuel tax rates, there are two major reasons by which most of the countries impose fuel taxes, which are ecological concerns and as a source of government revenue (the weight given to each of the reasons varies from country to country). In terms of ecological concerns, fuel taxes are advocated as a way to reduce pollution. Nevertheless, what we have seen over the most recent years is not a decrease in fuel aggregate consumption but actually an increase (in general). The governments´ goal of decreasing the consumption of fuel (ecological concerns) has not succeeded because of the lack of substitution production factors as well as strong difficulties to move around without transportation. Although fuel taxes are not enough to reduce in a significant amount the consumption of fuel, they induce a distortion as people, facing a lower purchasing power, decide to consume less of some goods in order to maintain the budget balanced.

Alexandre Marques Correia da Silva  

Student Number : 630

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Author: studentnovasbe

Master student in Nova Sbe

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