The petrol price is about to get pricier

As I noted in this post earlier in the week, my ECONS101 class has just covered the supply and demand model. Once you've seen it and you know how to apply it, it's hard not to see supply and demand everywhere. Take this article from the New Zealand Herald last Monday:

Petrol prices in New Zealand are the highest in nearly six months and commentators in other countries are warning there could be more pain to come at the petrol pump...

The Daily Telegraph reports Libyan National Army leader Khalifa Haftar has global oil markets in the palm of his hand and the international community is powerless to stop him.

His lightning-strike campaign across the North African coastal plain is another reminder of how vulnerable the world's most important commodity is to political turmoil...

There are lots of points in the article that explain why oil prices (and along with them, petrol prices) are likely to rise in the future. As an illustration though, let's just focus on the effect of a disruption in the supply of oil from Libya. The impact on the market for oil is shown in the diagram below. The market is initially in equilibrium, with a price of P0, and Q0 oil is traded. The events in Libya reduce the supply of oil (from S0 to S1), because at each and every price there would be less oil available. The price of oil increases (from P0 to P1), and the quantity of oil that is traded (and consumed) falls from Q0 to Q1 (but note that the decrease in quantity is only small, because the demand for oil is very inelastic - the demand curve is very steep).

The higher price of oil flows through to petrol prices, because oil is the key input into the production of petrol. Higher oil prices means that the costs of petrol production increase, which reduces the supply of petrol (or shifts the supply curve for petrol upwards). So, the impact on the market for petrol is also shown in the diagram above - a higher price at the pump.