Greenhouse gas emissions and price elasticity of transport fuel demand in Belgium - Essay Example

? Greenhouse gas emissions and price elasti of transport fuel demand in Belgium In the article, “Greenhouse gas emissions and price elasticities of transport fuel demand in Belgium” the price elasticity of demand for fuel plays a significant role in analyzing the reduction of greenhouse gas emission from Belgium transport sector through intervention by the Belgian government. The policy of increase in fuel tax by the Belgian government is taken into consideration in this article. The paper seeks to find the impact of an increase in fuel taxes on the consumption of fuels by estimating the price elasticity of fuel demand. Backdrop of the article The Kyoto protocol, named after the Japanese city, is an international agreement concluded in 1997, aimed at the reduction of the accumulated greenhouse gas emissions of the developed nations and lessening the intensity of global warming1. Since the start of negotiations on Kyoto Protocol, Belgian government adapted an ambitious position in the climate regime in the European as well as in the international level2.Belgium has also participated in the targets of reducing the greenhouse emission and has been successful overall in cutting down the intensity of emission by the importance of nuclear energy. But the intensity of emission is high in some sectors like heavy industry residential heating. But severe instances of emission are found to be generated in a rigorous basis from the road transport sector in Belgium which represents 20% of the all Green house gas emission3. Belgium is a small country in the respect that it is a price taker of the fuel prices in the international market as its demand has little or no effect on the international oil price. So the supply curve faced by Belgium can be thought to be infinitely elastic. Thus a change in the tax structure of the country is directly and fully gets reflected on the domestic prices and the quantity (fuel consumption) is directly related with the price elasticity of demand for fuels. Thus the prime parameter on which the quantity that is the fuel consumption depends in this case can be considered to be price elasticity of demand of fuels and thus we will analyze its impact with the help of theoretical understandings. Elasticity of demand Before moving into the realms of the topic in consideration it is necessary to clearly understand the concept of elasticity of demand. The elasticity of demand refers to the degree of responsiveness of quantity demanded of a commodity to a change in any of its determinants viz, price of the commodity, price of other commodities and income of the consumers. But in this paper we are only concerned with the price elasticity of demand4. Price elasticity of demand “The price elasticity of demand measures the sensitivity of the quantity demanded to changes in the price”5. In other words it is a measure of how much a quantity demanded of a commodity changes when its price changes. Mathematically the price elasticity of demand can be represented as the ratio of the percentage change in the quantity demanded of a commodity to a given change in price. Thus, Where, = Price elasticity of demand, = Change in quantity, =Change in quantity demanded6. Fig.1 In the above diagram the initial price was P0 and the quantity demanded was Q0. When price rose to P1 the quantity demanded falls to Q1 following the law of demand which states that for a normal commodity as price increases the quantity demanded falls as a result. In the diagram, the gap and the gap . Different types of price elasticity of demand The numerical value of price elasticity of demand varies from zero to infinity. In terms of its numerical value (i.e, degree of elasticity), there are generally five types kinds of price elasticity of demand. A. Perfectly Inelastic demand When the quantity demanded of a commodity does not respond to the change in its price, then the elasticity of demand is said to be perfectly inelastic demand. The numerical value of inelastic demand is zero7. Fig. 2 In the above diagram the quantity remains fixed at the point Q0. Although the price changes there is no effect on the change in the quantity demanded. Here and and so the value of the price elasticity is also zero because of the ratio as in the denominator B. Perfectly elastic demand When the quantity demanded of a commodity changes rigorously with an infinitesimally small change in price or no change does not respond to the change in its price, then the elasticity of demand is said to be perfectly elastic demand. The numerical value of inelastic demand is infinity ()8. Fig.3 In the above diagram the price remains fixed at the level P0 but at that price the quantity demanded is very large. Thus in this case and . The value of elasticity in this case is because of the ratio as in the denominator C. Elastic demand Fig.4 The price elasticity of demand is said to be elastic when the percentage change in the quantity demanded of a commodity exceeds the percentage change in its price. The value of elastic demand is greater than unity. In the above diagram the alteration in quantity is greater than that in price of the commodity. In this case < i.e, the percentage change in the quantity is greater than the percentage change in price. So the value of elasticity is also greater than 1. D. Inelastic demand Fig.5 When the percentage change in the quantity demanded of a commodity is less than the percentage change in the price then the price elasticity of demand is said to be inelastic and its value is less than 19. In the above diagram the change in quantity is smaller than change in price of the commodity. In this case > i.e, the percentage change in the quantity is lesser than the percentage change in price. So the value of elasticity is greater than 1. Unit elastic demand When the percentage change in the price of the commodity causes an equivalent percentage change in the quantity demanded, then the elasticity is said to be unit elastic. Fig. 6 In the above diagram the change in quantity is equal to the change in the price. In this case = and thus the ratio =1. Impact of increasing fuel taxes to reduce Green House Gas Emissions in road transport-A diagrammatic approach Over the last decade the correlation between the fuel consumption and the price changes has been a major topic of discussion. Transport constitutes approximately 27% of the total OECD carbon dioxide emissions and among them 80% accounts to the road based transport10. Transport sector fuel emission has attributed to approximately 4 to 9 percent reduction in sulphur dioxide (SO2) in the atmosphere11. The quantity of fuels used in the road transport is highly responsible for the emission from this sector. To reduce the emission, a large scale reduction in the fuel consumption is required. For this reason the policies needed to be implemented are “the tighter fuel economy standards for vehicles, road taxation, development of public transport and higher taxes on cars or transport fuels”?12. In general the results of the tax increase in a fuel market generally depend upon the characteristics of both demand and supply. In a small country like Belgium, in the international oil market the demand of fuel will most likely to have a very little influence or no influence on the fuel price. Thus it can be assumed that the national market for road fuels, supply is infinitely elastic i.e, they face a horizontal supply curve13. Fig.7 In the above diagram the supply curves S1 and S2 are infinitely elastic. Before the imposition of the fuel tax the price was at the level P0. Now after the imposition of the fuel tax , the supply curve increases to S2 from S1 and hence the price level also increases from level P0 to P2 level. The reduction in fuel consumption can be seen in the graph from level Q0 to Q1. Now the magnitude of reduction in the fuel consumption will depend upon price elasticity. If the demand curve is flatter as compared to the D i.e, if it be at D1 then the reduction in the fuel consumption would much greater and the fall in quantity would be from Q3 to Q1. This is the case of elastic demand. Now if the demand curve becomes steeper as compared to D to D2 then the reduction would have been smaller i.e, from Q2 to Q1. This is the case of inelastic demand. Empirical estimates in Belgium and price elasticity Empirical estimates states that in Belgium the short-run price elasticity of total fuel demand is around -0.18 14. The negative is used to indicate the law of demand which states that a negative relation exists between and price and the quantity demanded15. By this statement it can be inferred that if there is an increase in the price of the fuel by 10% from one year to another then the fuel consumption will be reduced by 1.8% in that year. The value of the medium run price elasticity was somewhat higher which stands at the value of -0.23. But this is still not a very big amount. From the analysis made in the paper it is clear that the price elasticity of demand to reduction in fuel consumption is inelastic. Thus it can be said that only imposing fuel taxes will not lead to lump sum reduction in fuel consumption. But it is still a good devise present in the hands of the government because the revenue earned from the fuel taxation can be reinvested in many fuel reduction methods and will help in the tax disequilibrium between the transport fuels16. Conclusion Responsiveness of the quantity demanded with price changes is the underlying notion of price elasticity of demand and the concept is applied in this paper in order to see a relation of quantity (fuel consumption) reduction with the increase in price Belgium. A significant amount of the green house gas emission evolves for the road transport sector of Belgium and it is the duty of the government to adopt various reduction policies. Increase in the fuel tax rate definitely reduces the fuel consumption in Belgium holding the supply curve (International oil price) to be infinitely elastic but large amount of reduction requires the demand curve to be highly elastic. But empirical results find that the price elasticity between oil price and reduction in fuel consumption is inelastic in Belgium and increase in the tax rate has only a small effect on the Green house gas emission. But in the other way round it can be said that a small reduction in the fuel consumption fetches additional revenue collection by the state which is a positive side. As the price elasticity is low or inelastic in nature for mammoth reduction in the consumption of fuel, the Belgian government needs to make high oil price hike but this may not be a feasible procedure as it can adversely affect the transport sector of the economy. Thus only sticking in the tax increase policy for Belgian government will not do. They need to formulate alternative strategies for the reduction of the greenhouse gas emission17. References 1. Elasticity, n.d., accessed May 8, 2012: http://www.econ.ohio-state.edu/jpeck/H200/EconH200L5.pdf 2. Elasticity of demand, n.d., accessed May 8, 2012: http://www.uri.edu/artsci/ecn/lardaro/ZV/Elasticity_of_Demand.pdf 3. Elasticity 1, n.d., accessed May 8, 2012: http://www.tutors2u.com/rte/File/Economics/ELASTICITY.pdf 4. Exploring the Kyoto Protocol, School Gen. 2008, accessed May 9, 2012: http://www.schoolgen.co.nz/pdf/exploring_kyoto_protocol.pdf 5. Globalisation, Transport and the Environment, n.d., accessed May 8, 2012: 6. http://www.oecd.org/dataoecd/19/45/45095528.pdf 7. Hecke, Karel V and Zgajewski, Tania, THE KYOTO POLICY OF BELGIUM, 2008, accessed May 8, 2012: http://www.egmontinstitute.be/paperegm/ep18.pdf 8. Principles of Microeconomics, n.d., accessed May 8, 2012: http://www.boisestate.edu/econ/lreynol/web/PDF/Elasticity.pdf 9. Rutherford, Thomas F. Quantitative Demand Analysis, 2011, accessed May 8, 2012: 10. http://www.cepe.ethz.ch/education/ManagerialEconomics/lecture3a.pdf 11. Schmitz, Tom, Greenhouse gas emissions and price elasticities of transport fuel demand in Belgium, OECD, April 26, 2012, accessed May 8, 2012: http://www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=ECO/WKP(2012)32&docLanguage=En 12. Strategies to Reduce Greenhouse Gas Emissions from Road Transport: Analytical Methods, OECD, 2002, accessed May 8, 2012: http://www.internationaltransportforum.org/pub/pdf/02GreenhouseE.pdf Read More