Report on the UK Petrol Market - Coursework Example

? Report on the UK Petrol Market Report on the UK Petrol Market Background Information The UK petrol market is important and dynamic. Since the publication of the Monopolies and Mergers Commission in 1990, there has been increased competition. The emergence of large supermarkets dealing in petrol has led to the decline of the major non-supermarket dealers such as Esso and Shell. Even the retailers of petrol have declined drastically owing to this wave of competition. The fall in petrol prices is also attributed to the increased competition among dealers of petrol in the UK. But there is a notable difference in prices between the rural petrol outlets and the urban ones. This could be justified by the additional costs of distribution and the low volume of sales in the rural areas (Harrison, 2011). Objectives of the Report To explain the meaning of ‘opportunity cost’ and ‘substitution’ To show how the concepts of ‘substitution’ and ‘opportunity cost’ could be used to analyse the changes in the equilibrium price in the UK petrol market. The concepts of Substitution and Opportunity cost Opportunity cost is the value of the next best forgone alternative. It results because of the scarcity of resource required to meet people’s needs. For example if one has $100, they can buy either a book or a watch. If they choose to buy a book, then the benefit they could have enjoyed if they had bought a watch would be an opportunity cost (Samidi et al., 2008). Opportunity cost can also result if as a result of price increase, the quantity bought reduces. For example if before price change a 100 litres of petrol at could be bought at$4,000 but only 80 litres could be bought with the same amount of money. In this case, the value of the 20 litres that is forgone after the price increase is an opportunity cost. This scenario also shows a substitution effect which is the difference between the quantity bought before and after the price change (Duguid, 2005). Substitution also results in a case where one is making a choice between two substitutes such as wheat and rice. If the price of rice is increased, the consumption of wheat is likely to be increased. Therefore, the difference between the quantity of wheat consumed before and after the price increase of rice is termed as a substitution effect. Equilibrium Price in the UK Petrol Market The figure below shows the changes in shifts in the equilibrium position as a result of the changes in the price of petrol. The X-axis represents the quantity of petrol while the Y-axis represents the Price of petrol (per Litre). X0, X1 and X2 represent the various equilibrium positions. Q0, Q1 and Q2 represent the litres of petrol bought at various prices. D0 is the demand of petrol while S0, S1 and S2 are the supply the supply curves. The Graph of Volume of petrol and its Price per litre           S1                                                       S0                           X1           Pe1               S2 Price per Litre     X0         Pe0                                           X2       Pe2                                                 D0                                                               Q1 Q0 Q2               Quantity (Litres)         Figure 1: Petrol Market Discussion The initial equilibrium position (where the supply curve, S0, intersect with the demand curve, D0) was represented by X0. At this equilibrium position, the consumer was able to buy Q0 Litres of petrol at a price of Pe0 per Litre. But if the price of petrol was increased to Pe1 per Litre, the consumer has to reduce the quantity consumed to Q1 litres from Q0 litres. The reduction of Q0-Q1 Litres is the volume of petrol forgone by the consumer owing to the price increase by P1-P0 dollars. The value of the foregone Litres of petrol is an opportunity cost which the consumer has to experience after the price change. The assumption made here is that the consumer’s income is limited and cannot be increased to meet the additional cost resulting from the price increase (Mabro, 1984). The above scenario where the equilibrium price shifts from X0 to X1 could also be explained using the concept of substitution. The consumers adjust their consumption rates to Q1 since they can no longer afford the initial volume of Q0. Therefore they will have to reduce the travel in terms of miles. If there were substitutes for petrol, they would have bought less petrol and buy more of the substitutes which would appear to be cheaper. But cars are made to use specific petroleum fuel, and the consumers have to buy less petrol and travel less miles than before. Conclusion The petroleum market is unique because if a consumer uses petrol, they cannot substitute with a different product like diesel. For those using petrol to fuel their cars, they have the option of varying the volume of petrol consumed. This means if the price of petrol is increased, the consumers will have to forego some travel in terms of miles owing to the reduced volume of petrol they can buy, keeping their income constant. This is a case of opportunity costs and substitution where the consumers react to price changes by reducing the consumption rates and thus shifting the equilibrium price. However, this report did not consider what happens to the complementary products of petrol, when the equilibrium price of petrol changes. Further research needs to be done on this area. References Duguid, M., 2005. Microeconomics: The UK Economy and the International Economy. Edinburgh: Learning and Teaching Scotland. Harrison, R., Thomas, R., & Weymarn, I., 2011. The impact of permanent energy price shocks on the UK economy. The Bank of England, Working Paper No. 433 Mabro, R., 1984. Oil Price Concepts. Oxford: Oxford Institute for Energy Studies. Samidi, M.A., Abdullah, N., Ali, J., & Mohaideen, Z.M., 2008. Fundamentals of Microeconomics. Malasyia: Prentice Hall. Read More