Friday, April 11, 2008

Cross price & supply effects of oil price changes

I always try to emphasise to economics students the importance of (a) cross price elasticity effects on demands and (b) the supply effects of price changes. These issues are particularly important for assessing the effects of recent surging primary energy prices which are having impacts throughout the economies of both developed and newly-emerging countries.

Liquid fuel prices have risen massively over recent years. During a recent trip to Asia I learned that fuelwood and charcoal resources in developing countries are again coming under intense pressure because they can provide effective substitutes replacing the use of fuels such as charcoal and kerosene. In Africa these effects are of limited extent because in many countries there charcoal already provides 80% of fuel needs. The difficulty is this potentially renewable resource is being depleted and rising fuel prices can be expected to accelerate this trend. Fuelwood resources in developed countries are coming under increased pressure because of increased prices of competing heating fuels – even sawdust is becoming expensive. Suprisingly too those developed country agricultural lands that were diverted towards biodiversity conservation are being redirected back into agriculture because of fuel-price-induced food price rises that stem from cost effects in energy-intensive agriculture and the diversion of crops into biofuels.

I have posted on the various linkages between increased fuel prices and increased food prices. In developing countries food prices rose 25% over the past year – wheat prices rose 120%. This is bad news for communities which spend 75% or more of the household budget on food. I notice in my own household budget that food costs are playing an increasing role.

Longer-term the effects of high liquid fuel prices will stimulate new technology developments and alternative sources of energy supply. These will eventually come to moderate the effects of higher liquid fuel costs on forestry, the environment and food supplies. But short-term expect quite a lot of economic pain.

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