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Global Oil Prices

Question

Answered

Read the following excerpts from the article ‘Petrol tipped to hit 85 cents’

published on 14 January 2015 and answer all of the questions. You are expected to

use graphs to explain your answer.

Petrol tipped to hit 85 cents

The West Australian, Andrew Tillett January 14, 2015

Petrol could plunge to as low as 85 cents a litre, according to one WA motoring body, as the

main global oil benchmark price drops below $US50 a barrel.

Bowser prices in Perth have continued to fall after reaching a five-year low last week, with

motorists today paying 106.7 cents a litre for the cheapest unleaded fuel, according to

FuelWatch.

With no sign the slide will stop any time soon, WA Motor Trade Association chief executive

Stephen Moir said petrol prices could go below $1 and hit their lowest level in 15 years.

Mr Moir said the oil industry was looking at a perfect storm as countries kept up or even

increased production, putting a price of $30 a barrel in the ball park if the trend continued.

"We're looking at a return to the prices we haven't seen since the late 90s," he said.

"You could be paying 85 cents to 90 cents."

The Royal Automobile Club said it was reasonable for West Australians to expect petrol

prices to continue falling as the oil price dropped but cautioned it would eventually hit a floor.

"Petrol prices of below $1 per litre are not out of the question," manager vehicles and fuel

Alex Forrest said.

"That would make it a six-year low, but motorists should also be aware that the lower it goes,

the more likely the possibility of an upward correction."

Amber Millar filled up her Toyota RAV4 at Armadale's Puma Energy service station, one of

the outlets selling Perth's cheapest petrol yesterday.

She said she was saving $20 to $30 a week and never thought petrol would get so low again.

"I'm loving it," she said.

"If you are on a budget week to week, it's a huge saving."

Mrs Millar said motorists would be "stoked" if petrol fell to 85¢ a litre. "It means you can

do a lot more with your money."

CommSec chief economist Craig James said while petrol was on track for $1 a litre, fuel

companies were unlikely to sustain prices below that mark.

Mr James said it would probably take a major oil producer such as Saudi Arabia saying it

wanted a target of $40 a barrel to stabilise the oil price.

If the oil price fell to that point, it would cut a further 5¢ off the petrol price here.

But the oil price would need to be $30-$40 a barrel to force producers to reduce supply, he

said.

"Effectively crude oil prices are in freefall," he said.

Mr James said the wholesale price in Perth yesterday was 104.6 cents a litre. That price would

need to dip below $1 before motorists paid a similar amount.

 

Questions

1. Assuming that petrol operates in a perfectly competitive market, use a well-labelled demand and supply (D-S) model to explain how market equilibrium price of petrol is being determined. Please clearly explain the equilibrating process. [4marks]

 

2. Using the demand and supply model, explain and illustrate what factors have caused the market price for petrol to fall. In your answer clearly explain the connection between the global wholesale price of oil and the price for petrol at the domestic retail level. Clearly explain the equilibrating process in the retail market for petrol. (Hint: use two demand and supply diagrams) [8marks]

 

3. Give an example of a complementary good to oil and use the demand and supply model to explain the likely impact on this related market in terms of changes to equilibrium price and output. [4 marks]

 

 

4. Do you think the demand for petrol is price elastic or price inelastic? Explain your answer based on the determinants of price elasticity of demand and also by making reference to the newspaper articles excerpts relating to the likely impact on consumers’ total expenditure on petrol. Use a diagram to illustrate your answer. [6 marks]

Global Oil Prices

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