An Economic Analysis of High Petrol Prices in New Zealand

This essay provides an economic analysis of the high petrol prices in New Zealand, examining the factors contributing to the rising costs. It explores the concept of price elasticity of demand for petrol, demonstrating how it influences revenue and profit margins for petrol companies. The assignment further investigates the impact of petrol tax, illustrating how the burden is disproportionately borne by consumers due to the inelastic demand. The essay identifies the role of both high profit margins of petrol companies and the tax imposed by the government as key drivers of the continuously high petrol prices. It discusses the potential consequences of lower petrol prices, including increased demand and potential market shortages, and concludes by advocating for government intervention to promote competition and increase social welfare. The analysis references relevant economic theories and data to support its arguments and recommendations.

Running head: ECONOMICS
Economics
Name of the Student
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Introduction
One of the serious concerns in New Zealand today is the soaring prices of petrol. In
petrol pumps, consumers now have to pay an unexpectedly high prices for petrol. Investigation
on reasons behind high petrol price reveals different factors leading to the high price.
Government blames petrol companies for excessively high price. The petrol companies on the
other hand pass on the blame to the government by stating that it is the petrol tax that leads to the
high price (Walls, 2019). The essay discusses current state of petrol price in New Zealand along
with evaluating factors leading to a high petrol prices in the nation.
Elasticity of petrol and high price
Price elasticity of demand represents an economic method that estimates proportionate
change in quantity demanded of a good because of relative proportionate change in own price
(Baumol & Blinder, 2015). Responsiveness of demand measured by elasticity of demand has a
crucial role to play in the pricing decision of firms. In case of petrol, both short run and long run
elasticity of demand is found to be relatively inelastic implying measured elasticity is less than 1
(comcom.govt.nz, 2019). This implies relative change in demand when price change is much
lower relative to change in price. Consequently, when price increases the fall in demand is far
offset by the high price resulting in an increase in revenue and profit margin. This permits petrol
companies to successfully increase price to obtain a higher margin.

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Figure 1: Elasticity of demand and revenue
Given the inelastic demand of petrol, the demand curve for petrol is given in the form of
a steep demand curve D1D1. With a surge in price of petrol from P1 to P2, revenue surges from
OP1AQ1 to OP2AQ2 resulting in a higher margin for petrol companies.
Burden of petrol tax
Incidence of tax is determined from the associated demand and supply elasticity. Larger
the elasticity lesser is the tax burden and vice versa. Given that demand for petrol is less sensitive
to price, price elasticity of demand is larger than the price elasticity of supply. Petrol companies
in this case can bypass a larger proportion of tax burden to the buyers (McKenzie & Lee, 2016).
Division of tax burden for petrol is illustrated in the given figure below.

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Figure 2: Impact of petrol tax
In the market for petrol, state of demand is represented by a relatively inelastic demand
curve of DD. The supply curve is flatter than the demand curve and is shown by SS. An imposed
tax shifts the supply curve left to S1S1. Because of the tax buyers of petrol faces a high price
corresponding to PB. Petrol companies however get a low price corresponding to PS. The
evaluation of petrol tax therefore shows that because of less sensitivity to price consumers of
petrol face a higher burden of tax.
Reasons for a continuously high petrol price
There are two factors that explain a high price of petrol. As stated by Prime Minister
Jacinda Ardern, it is fuel companies that raise the petrol price to the high level. In this regard,
fuel importing companies like Z Energy, Mobil, BP and Gull are particularly responsible for a
higher price. Driving by a higher profit margin these companies are pushing up prices. Evidences
show that importers experienced an increase in margin by more than doubled (7% to 16%)
between 2008 and 2017. Some leader though blamed the practice of fuel tax for a higher petrol
price the tax however constitutes only a small proportion of increased price. In the most recent
hike of petrol price by 39c, share of tax is only 6.8c (Walls 2019). Even without tax fuel cost in

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New Zealand was higher compared to other OECD nations. This was in contrast to the recorded
lowest price in 2008. The anti-competitive behavior of petrol companies has led to price of petrol
in New Zealand.
Impact of a lower petrol price
High petrol price in New Zealand is explained is the result of both higher profit margin of
companies and tax imposed by government. Now, if government managed both to make petrol
companies lower profit margins and to lower its tax on petrol, then it will result in a decline in
petrol price (Walls, 2019). Following standard law of demand, a fall in petrol price increases
quantity demanded of petrol.
As stated in the article consumers in New Zealand are fleeced with high petrol price.
Given the relatively lower price elasticity of demand, buyers face a higher tax burden. Lowering
the price of petrol makes petrol affordable to buyers (Cowen & Tabarrok, 2015) By relieving tax
burden this benefits the society in terms of a higher social welfare.
Lower price may discourage petrol companies to supply petrol. The fall in supply of
petrol because of a lower price leads to a shortage of petrol in the market. Shortage of petrol has
some unintended consequences like black marketing or long queues at petrol pumps (Nicholson
& Snyder, 2014)
Need for government intervention in the market
Anti-competitive behavior of petrol companies allows them to charge a high petrol price.
Limited competition in the market increases market power of the dominating companies.
Government intervention therefore is needed to control the market power. Government should
encourage more competition in the industry. Increase in competition reduces market power of the

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dominating firms and lowers price to the competitive level (Mahanty, 2014). The lower price
benefits consumers by making petrol available at a lower price. In the competitive environment
resources are allocated more efficiently increasing social welfare.
Conclusion
Demand elasticity is an important determinant of revenue of firm. Demand of petrol is
relatively less responsive to price. This allows petrol companies in New Zealand to increase their
profit margin by charging a high price. Following a relatively inelastic demand a petrol tax
imposes a higher burden on consumers compared to sellers. The tendency of petrol companies to
obtain a large margin results in a high petrol price. The imposed excise tax on fuel is further
leads to a high price. Even of government lowers the tax, because of anti-competitive behavior of
existing companies would continue to give an upward pressure on price. Government
intervention therefore is needed to lower petrol price and increase social welfare.

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References
Baumol, W.J. & Blinder, A.S. (2015). Microeconomics: Principles and policy. Nelson
Education.
comcom.govt.nz (2019). Market study into the retail fuel sector Comcom.govt.nz. Retrieved 5
October 2019, from https://comcom.govt.nz/__data/assets/pdf_file/0032/168359/Retail-
fuel-market-study-Draft-report-20-August-2019.PDF
Cowen, T. & Tabarrok, A. (2015). Modern principles of microeconomics. Macmillan
International Higher Education.
Mahanty, A. K. (2014). Intermediate microeconomics with applications. Academic Press..
McKenzie, R.B. & Lee, D.R. (2016). Microeconomics for MBAs: The economic way of thinking
for managers. Cambridge University Press.
Nicholson, W. & Snyder, C.M. (2014). Intermediate microeconomics and its application. Nelson
Education.
Walls, J (2019). PM Jacinda Ardern doubles down on comments that consumers being 'fleeced'
at the petrol pump. NZ Herald. Retrieved 5 October 2019, from
https://www.nzherald.co.nz/nz/news/article.cfm?c_id=1&objectid=12260184
Walls, J (2019)'Consumers, in my book, are being fleeced' - PM Jacinda Ardern on petrol prices.
NZ Herald. Retrieved 5 October 2019, from
https://www.nzherald.co.nz/nz/news/article.cfm?c_id=1&objectid=12138957