The Impact of Rising Oil Prices on the South African Economy – Assignment

The Impact of Rising Oil Prices on the South African Economy – Assignment Words: 1127

A continual upward trend in the price of crude oil in recent years has led to increasing concerns about its economic implications, both abroad and in South Africa.

This study looks at the rising oil prices and their impact on the South African economy within the framework of supply and demand, looking at the impact rising oil prices has had on demand and supply for vehicles as well as the impact on South African GDP growth. Cognisance must be taken of the fact that this slowdown in car sales is not only related to high fuels prices but is also as a result of successive increases in domestic interest rates, the introduction of the National Credit Act, high debt levels among consumers, and high levels of debt-servicing costs.

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For the purpose of this assignment these factors are not considered. SUPPLY VS DEMAND The demand for goods refers to the relation between the price of a good and the quantity of the good that consumers will be willing to pay for it. Oil has a relatively inelastic demand mainly due to the fact that there currently is no suitable and viable product substitute for it. Despite world production problems, rising prices, war and economic slow down at various periods, the price of oil has shown a resilient projected increase in price see fig 1). Oil price is very price inelastic. Fig 1. Source: WTRG Economics (2007) The oil supply demand relationship has, to an extent fuelled or influenced, the oil price hikes however this cannot be established as a fixed indicator of the rising oil price trend. Fig 2. Source: WTRG Economics (2007) However when looking at the cross price elasticity of demand of motor vehicles in relation to Oil, we see a highly elastic environment. Fig 3. Source: NAAMSA(2008)

The comparison of the two graphs(fig 2 and fig 3) show that the surge in oil prices, although not influencing demand for oil, has had a downward push on the demand for new vehicles especially since late 2006 going into 2007, which has seen a marked increase in oil prices. This has impacted the supply of motor vehicles as exports have decreased during 2007. Although oil imports rose by a significant R3. 1 billion, imports of vehicles and parts decreased by a substantial R807 million reflecting a weakening in domestic sales.

In an attempt to achieve market equilibrium i. e. where new vehicles manufactured equal demand; local manufacturers have reduced vehicle assembly industry capacity levels to 67. 7% in 2007. This has reduced supply and has been based on predicted sales targets for 2008. FINDINGS Bearing in mind the volatile financial market conditions, lower levels of consumer sentiment and dropping business confidence – the short term outlook for the domestic automotive industry remains negative.

The delayed effect of interest rate increases, growing pressure on consumers as a result of sharp increases in inflation, especially energy and food, will reinforce the negative trend. Additionally, most importers and manufacturers have implemented price increases to partly recover the relentless and record cost increases in materials and automotive inputs and to compensate for the weakness in the exchange rate. In most instances, however, price adjustments remain well below the domestic inflation rate.

In contrast to the weaker domestic sales environment (with the exception of the heavy commercial vehicle segment which continues to be supported by the infrastructural development boom), production of new motor vehicles continues to receive support from higher vehicle exports. The substantial growth in vehicle and component exports will lend support to local vehicle and component manufacturing operations. Overall, NAAMSA anticipates that business operations dependent on the domestic market will continue to remain under significant pressure for the balance of 2008 and into 2009.

PRIMARY FACTORS Taking into account the primary factors that can cause a change in demand (or a shift in the demand curve) are •consumer income •prices of related goods •advertising and consumer preferences •population •seasonal factors Understanding these factors in relation to rising oil costs and vehicle demand makes it possible to predict the market response to real economic events. Consumer income Over the year’s South African consumer income has increased which has resulted in an increasing demand of motor vehicles. The demand for inferior goods (i. e. ublic transport) decreased as more people chose to purchase their own vehicles. Prices of related goods Changes in the price of related goods (substitutes and complements) leads to changes in demand. An increase in the price of Oil as a complement good has caused a decrease in the demand of Motor Vehicles especially since the late 2006 when there has been a steep increase in the oil prices. Advertising and consumer preferences Consumers are becoming more environmentally conscience and this has resulted in a steady demand for eco-friendly modes of transport.

With the introduction of hybrid vehicles as well as plans to improve public transport within South Africa consumers are becoming less reliant on the necessity of a motor vehicle as an only means of transport. Population The growing increase in population of consumers has increased demand. This is particularly relevant amongst the working generation of 20-30 years who form part of the first time vehicle buyers. Seasonal factors The influx of cheap Chinese car models has made the ownership of a new vehicle much more affordable.

This can fuel the increase in market demand for imported vehicles but can negatively impact the market demand for high end cars. CONCLUSION Overall business operations dependent on the domestic market will continue to remain under significant pressure for the balance of 2008 and into 2009. Although the price of fuel plays a part in market demand – stimulating market choices thru various innovative financial options and product differentiation can improve demand. A lot of the local manufacturing companies have spare capacity and will be able to fall in line with market demand should industry require that.

REFERENCES Association for the Study of Peak Oil and Gas (ASPO). 2006. Newsletter No. 69. Available online: http://www. peakoil. ie/newsletters Bellamy, D. 2006. “The Macroeconomic Effects of the Crude Oil Price on the South African Economy. ” Unpublished Master’s Dissertation, University of Cape Town. National Association of Automobile Manufacturers of South Africa (NAAMSA). “Quarterly review of Business conditions: 2nd quarter 2008”. Available online: http://www. naamsa. co. za /papers/2008_2ndquarter Republic of South Africa (RSA). 006. “Accelerated and Shared Growth Initiative for South Africa ¬ AsgiSA. ” Office of the Presidency. Available online: http://www. info. gov. za/asgisa/asgisa. htm South African Petroleum Industry Association (SAPIA). 2006a. Basic Fuel Price Formula. Available online: http://www. sapia. org. za/pubs/fuelprice/index. htm Wakeford, J. J. 2006. “Risks to Global Trade and Implications for South Africa’s Economy and Policy. ” DPRU Working Paper No. 06/111, July 2006. Development Policy Research Unit, University of Cape Town.

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