ECO6201E Business Economics – Oil Prices, Elasticity & EVs

High oil prices due to the Iran war weigh on everything from the petrol pump to consumer goods

Choking of Hormuz sends energy prices surging and everyday costs higher

NEW YORK: Pain at the pump. Flights canceled, costlier airplane ticket prices and baggage fees. Everyday items such as soap and toothpaste getting more expensive. Higher postal prices.

Consumers are paying for the Iran war ‘s disruption of global energy production as the conflict enters its third month. Steeper petrol, diesel and jet fuel prices are making driving and air travel more expensive. Many companies warn there’s more to come: the cost of fuel and of materials derived from petroleum could drive up prices for food and for household items.

Iran has closed the Strait of Hormuz to oil tankers, keeping them pent up in the Arabian Gulf and away from customers worldwide, while a US Navy blockade is preventing Iran from selling its own oil. Prices surged overnight on worries that the war will affect the flow of crude for a long time.

US petrol surges to highest level since 2022

As the cost of crude climbs, so do the prices of petrol (gasoline) and other fuel that keep equipment, cars, buses, delivery trucks and airplanes running. Across the U.S., gas prices are at their highest level since 2022. The national average hit $4.30 a gallon on Thursday, compared with $2.98 before the war started, according to AAA. That’s a 44% increase since the U.S. and Israel attacked Iran on Feb. 28.

Diesel prices are making shipping cost more

Steep diesel prices are making it more expensive to haul everyday goods. Diesel is now at an average of nearly $5.50 a gallon, up from $3.76 before the war, AAA says. Shippers have started adding surcharges to cover the cost. The U.S. Postal Service implemented a temporary 8% charge on some of its services, including Priority Mail, to help blunt the impact of rising transportation costs. Amazon added a 3.5% fuel and logistics surcharge on third-party sellers using its platform to offset fuel prices as well.

Shoppers may see more sticker shock for clothing, cosmetics, furniture and other goods.”Diesel’s the one that you want to watch out for for prices of consumer goods,” said Peter Zaleski, professor of economics at Villanova University.

Plane tickets are getting pricier

After jumping to $209 a barrel in early April, the global price of jet fuel eased last week to around $179, still well above the roughly $99 at the end of February. Fuel is one of the largest expenses for airlines. Its prices are pushing up airfares, baggage fees and add-on charges.

Major U.S. carriers including Delta, United, American and Southwest have raised checked baggage fees. United is expanding its “pay for what you want” model from economy to premium cabins, charging separately for options like seat selection. American is adding fees for seat assignments in basic economy, even for its elite-tier loyalty members.

Outside the U.S., carriers in Asia and Europe have added or raised fuel surcharges, in some cases tacking on hundreds of dollars to long-haul tickets.

Many airlines also have trimmed flight schedules, cut less profitable routes or reduced seat capacity. The Lufthansa Group has said it plans to cancel about 20,000 flights across its network over the next six months.

Consumer goods makers are raising prices

Procter & Gamble, the maker of such household products as Crest toothpaste, Tide detergent and Charmin toilet paper, warned last week the war would cause a $1 billion hit to profits during its next fiscal year. Many of P&G’s products and packaging are made of resin or other petroleum-based material, Andre Schulten, P&G’s chief financial officer, told reporters on April 24. He said the company may have to pass on some of the costs to shoppers.

London-based Unilever, which makes everything from Dove soap to Hellmann’s mayonnaise, plans to raise prices around 2% to 3% in “small doses,” CFO Srinivas Phatak said in an earnings call on Thursday. Groceries could be next. Grocery prices have yet to be affected, according to government figures. But they are expected to rise with tightening supplies of fuel and fertilizer.

Question 1

Using appropriate diagrams, analyse how the closure of the Strait of Hormuz affects the global oil market.

(Hint: You can use illustrations such as graphs to explain the situation)

Question 2

Evaluate the price elasticity of demand for petrol and air travel in response to rising fuel prices.

Question 3

Critically evaluate the role of government intervention in stabilising fuel prices. Should governments impose subsidies or reduce taxes on fuel? Analyse the impact on consumers, producers, and government budgets.

Question 4

Malaysia has been actively promoting the adoption of electric vehicles (EVs) through various policy initiatives and incentives. To what extent can the increased adoption of EVs mitigate the economic impact of rising petrol prices in Malaysia? Discuss using relevant economic concepts.

Experts Answer on Above Questions on Business Economics

Impact of the closure of strait of Hormuz on the Global Oil market

An analysis of the impact of closure of strait of hormuz on the global oil supplies indicates that it has a significant impact as the strait controls 20% of the global oil supplies. As a result, the Global Oil supply curve would shift leftward as indicated in the diagram in appendix, from S1 to S2 whereas the demand is relatively unchanged. The effect of this situation is an increase in the oil price as indicated from P1 to P2, quantity traded decreases from Q1 to Q2, the crude prices increase significantly during the crisis situation, and countries that are highly dependent on import of global oil face increased transaction costs. The economic impact as a result is an increase in the inflation level, higher prices for fuel, electricity and logistics, reduction in the consumer purchasing power, and slow down in the growth of the economy.

Price elasticity of demand for petrol and air travel

The price elasticity of demand for petrol is inelastic because it is an essential commodity for commuting and transportation, and has limited short term substitute. It is clearly evident from the increase in the petrol price in the US but there is no such proportionate fall in the consumption. With respect to air travel the price elasticity of demand is relatively elastic because it is possible to postpone leisure travel and there are alternative modes of transportation available for short distances.

Government intervention to stabilise fuel prices

The advantages from government providing fuel subsidies are lower transportation cost for the consumers, reduced inflationary pressure and increased disposable income. On the businesses, they benefit from lower logistics and production costs, and stable operating expenses. On the negative side, the government faces significant fiscal burden, larger budget deficits etc.

Alternative – reduce fuel taxes

Reduction in taxes of fuel would lead to immediate reduction in the pump prices, and it is less costly compared to direct subsidies. The disadvantages are lower government tax revenue, and it will benefit high income consumers more because they make higher usage.

Can EV adoption reduce the economic impact of rising petrol prices in Malaysia?

Substitute goods

EVs act as a substitute for petrol prices, and with the increase in the price of fuel, the demand for EVs increases whereas the demand for petrol decreases.

Cross price elasticity of demand

Hire the prices of petrol, there are better chances of consumers purchasing EVs. For example, a driver spending RM800 monthly on petrol can achieve significant reduction in their operation cost by switching to EVs.

Reduce exposure to oil price shocks

With higher adaptation of EVs in Malaysia, it would result in reduction in the fuel consumption, lower dependence on Global Oil market and improves energy security.

Government incentives

Government can adopt policies such as input duty exemptions, road tax incentives and significant investment in the development of EV charging infrastructure.

Want Detailed Answers with References?

It is evaluated that the impact of the Strait of Hormuz crisis is significant on the Global Oil prices, as fuel prices increase. The analysis of demand elasticity, government intervention and policies, and EV adoption in Malaysia showed their impact on oil prices and dependence. With our economics expert, you can avail a similar kind of analysis for your economic assignment by simply purchasing our economic assignment help services in Malaysia.