Petrol, tax, and the downward sloping demand curve.

Nearly every country has a tax on petrol, although the amount varies widely. And given that the landed price of petrol is quite similar (see the graph below), it can be seen what effect the tax has on quantity demanded. The results are very much in line what economic theory would predict and there are also clear implications for countries that want to reduce petrol consumption.

The first graph shows the price of petrol in OECD countries and then the component of taxation levied per litre. Notable is the very low level of tax in the world’s biggest consumer of petrol - the USA.

The second graph shows the price per litre plotted against consumption per person. While there is a definite cluster of points, countries with a relatively low tax per litre give the curve a clear downwards slope.

So if a country wants to reduce petrol consumption, the answer seems obvious - a higher tax rate and therefore price will lead to lower consumption. However, this is often not politically acceptable and this is a problem that is probably most acute in the USA, even though current taxes are already very low. An alternative could be a reduction in petrol consumption via technology that increases fuel efficiency. This is easier said than done, with hybrid and electric cars remaining very expensive for now. And as the following graph for the Honda Accord shows, a large proportion of the gains in fuel efficiency in the past 30 years has gone in to increasing the weight and power of the cars.

The top two graphs are weight and horsepower, the bottom two torque and fuel economy. As can be seen, fuel economy is the only measure not steadily increasing.

So the solution seems clear if a government has the political will to implement it. Otherwise, if reducing petrol consumption is a goal then other measures may have to be implemented. It would be worth a classroom discussion / groupwork activity brainstorming what some of these ideas might be!

Sources include econbrowser.com and HaywardEcon blog