Why does the price of oil keep escalating over the past century, and recently reach new peaks? In general, the answer to the question is directed to few main contributing factors that are unexpected closure of oil production, on-going Iraq war, destructive natural disaster and further increment of government taxes on petrol. These factors closely play a part in affecting the supply and demand of oil in the commodity market where the consequence of these factors often raised the price of oil.
Taking an illustrative example, one can observe clearly that the unexpected closure of a major oil production (Anadarko Petroleum Corporation) in Gulf of Mexico due to the storm of Hurricane Rita (www.oilonline.com, 2005) has significant impact on reducing world’s supply of oil where the reduction in supply ultimately increases the price of oil even when the demand for oil remains unchanged.
Economists usually observe this effect as the law of demand (Begg etl 2003:P27). Undoubtedly, since oil is the main source of energy supply of running motoring in the world, the impact on buyer demand for car, bus and train travel due to further raise in the costs of motoring would be greatly affected. Normally, as observed by most Economists, the impact would be of a reduction in consumer demand for motoring (Lipsey ; Chrystal 2004:P44). Hence, this essay aims to deliver the answers to why the reductions in buyer demand for motoring by briefly illustrating few important economic theories such as demand analysis, price elasticity and income elasticity.
In theory, the total quantity demanded depends on the price of the product being sold, on the prices of all other related products, on the incomes of the consumers buying in that market, and on their tastes (Sloman 2001:P33). In context, this means that the four main factors that are affecting consumer demand for motoring such as car, bus and train travel are the price of motoring, the price of motoring dependable product i.e. oil, the incomes of consumer whom require motoring for transportation in their everyday life, and the tastes of consumer in motoring. Clearly, all these factors contribute to the impact on buyer demand for motoring. To illustrate further, motoring and oil tend to be closely related with each other are theoretically described by Lipsey ; Chrystal (2004:P44) as complements.
Hence, a sudden rise in the price of either will reduce the demand for both since complements tend to be captivated together. For example, an escalation in the price of oil that causes increment in the costs of motoring will reduce the demand for cars, bus and train travel. Another interesting analysis may be observed is that if there is a change in tastes in favour of a product, more will be demanded at each price, causing the demand for that product to increase (Sloman, 2001:P34).
This means that if relatively more consumers have sudden strong appeal of requiring motoring, for example more individuals still purchase cars and take train rides despite the fact of the increased costs of motoring, the demand of motoring will be believed to increase. Although both analyses seem true in context, first analysis may seem more rational in this modern world over the second one due to the fact that consumers like you and me are more likely to be easily influenced by the price of the product rather than the tastes in favour of the product for the demand of the product, in this case, motoring.
Another in-depth examination of the impact on consumer demand for motoring is to measure the responses of the quantity demanded and the quantity supplied to changes in variables that govern them, in particular, prices and incomes (Lipsey ; Chrystal, 2004:P59). It is often insufficient to appreciate just whether quantity of a product increases or decreases in response to some contributing factors.
It is important to understand by how much it increases or decreases from learning and measuring the responses of the quantity, which is also known by Economists as the concept of elasticity. This concept involves two important studies, mainly elasticity of demand and income. In brief, price elasticity of demand is defined as the percentage change in quantity divided by the percentage change in price that brought it about (Begg etl, 2003:P41).
Hence, it is easy to understand that the impact on consumer demand for motoring as the price elasticity of demand usually exceeds unity, but not much i.e. close to unity, as the increase in the cost of motoring due to the high price of oil will reduce the demand but not significantly. The obvious reason is that oil is main energy supply of maintaining the use of cars, buses and train travels in the world, while the availability of other satisfactory substitutes to replace oil is lacking in the present world. Hence, it is creditable to state that the price elasticity of demand of oil tends to have an inelastic nature, as there are no close or satisfactory substitutes.
However, it is untrue to state that the demand of motoring due to further increase in the costs of motoring from the effect of high price of petrol is inelastic as well, as minority of the consumer may consider replace the means of motoring by walking or cycling. Hence, the demand of motoring from the impact of high price of oil is better to be described as the case for a smaller fall in quantity demanded due to a rise in their price, as generally, motoring as a whole is often treated as a necessity of life with few satisfactory substitutes. This means that the responsiveness of quantity demanded of motoring to the changes in the prices of oil is usually of substantial interest, where the reasonable term to describe this responsiveness is called cross-elasticity, according to Begg etl (2003:P47).
In general, it is often argued that a change in income would vary the demand for a product (Lipsey, 2004:P68). However, for certain product such as motoring which is highly petrol dependable, there is another aspect of the dominance of income on the demand. Taking example into context, a rise in the costs of motoring may cause more revenue to spend on it, but to a limit. Basically, if a consumer is to spend all his income on the costs of motoring, then the demand for motoring must have unit elasticity, which is not likely to happen in the real world.
Therefore, as the costs of motoring increases, purchases must then follow in proportion as consumer has only limited income to spend on. This means that although consumer may be willing to spend more for the increased costs of motoring, the demand for motoring will still experience gradual reduction as the higher the proportion of the income is to be spent on a product, the less likely that more will be spent on it when the price of the product rises.
In conclusion, the impact on the demand for motoring due to the further increase in the price of oil has been careful analysed by using three important economic theories. The demand analysis provides knowledge in understanding the management in which the demand of a product will change in response to its price and prices of any other related product. On the other hand, price and income elasticity measurement provide detail analysis of the degree of impact on the demand for motoring in the real world. Hence, it is important to develop useful concepts that will provide the knowledge to understand how the real world markets work.