High fuel prices a good thing?

One Australian economist thinks so. Excerpt:

One good thing about next week's federal budget is that even though Peter Costello is flush with cash and likely to offer tax relief to families, he's unlikely to make any cut in the tax on petrol. That's a good thing because we must learn to live with high petrol prices, not find ways to duck them. With prices nudging $1.40 a litre in some cities and Costello warning that worries about the Iranian nuclear stand-off could push them up to $1.60, the motoring lobbies are looking for ways to ease the pain. The Royal Automobile Club of Victoria, for instance, wants Costello to remove the GST on fuel excise, saving about 3.4 cents a litre.

But, whichever way you look at it, cutting the tax on petrol would be the wrong way to go. For a start, there's the conventional economists' argument that the best response to higher prices is higher prices. Huh? When you think about it, it's not as meaningless as it sounds. Prices rise when the demand for something is growing faster than its supply. Although part of the rise in oil prices is based on speculation about disruption in the Middle East, and so may not last long, the underlying increase in demand is coming from the rapid growth in the economies of China, India and other developing countries. This is likely to keep upward pressure on oil prices for many years.

But in a market system, a rise in the price of such a commodity prompts a change in behaviour. It increases supply by encouraging exploration for new sources, makes formerly uneconomic oilfields profitable and encourages the development of substitute fuels. At the same time, it reduces demand by encouraging consumers to use petrol more economically and search for cheaper substitutes. Put this reduction in demand together with the increase in supply and you see that a rise in prices should lead to a fall in prices. So allowing retail petrol prices to move in response to market forces is the best way to minimise the long-term rise in prices likely to come from the developing world's increasing demand for oil.

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