Friday 16 September 2011

Quick Economics - Petrol price hike - how it works.

Assume that the price of one litre of crude oil (from which Petrol is made) is one US Dollar (USD). Also, assume that an USD (US Dollar) can be purchased from a Bank for Rs. 42.  This means the cost of a litre of crude oil is Rs. 42/-. After adding other input costs, processing costs, overheads, taxes, profit margins, etc., the selling price of Petrol would be  determined.

Scenario 1: The price of crude oil remains stable but the rupee weakens: Assume that over a period of time the rupee weakens (i.e. you need to pay more rupees to buy one unit of a foreign currency, in this case the USD) and the price of a USD has risen from Rs. 42 to Rs. 56.  This means that for a litre of crude oil you need to pay Rs. 56 now as against Rs. 42 earlier. Other things remaining the same, the selling price of Petrol is  bound to go up.

Scenario 2: The price of crude oil goes up but the rupee remains stable:.  Assume that the seller abroad has hiked the price of crude oil to USD 1.33 per litre.  Now you have to pay the rupee equivalent of USD 1.33 i.e.  Rs. 56 to buy a litre of crude oil. Other things remaining the same, the selling price of Petrol is  bound to go up.

We can conclude that the price of imported goods/services are bound to go up when the price of the foreign currency goes up or there is a hike in the  price of the foreign goods/services.

A weak rupee and impact on exporters. The above scenario covered importers, people who pay in Foreign exchange. What about exporters (IT Companies/BPOs, manufacturersm etc), people who receive money in Foreign currency for goods / services sold ? In the above example, these people will benefit from a weak rupee as they will be able to get Rs. 56 now as against Rs. 40 earlier for each USD that they will convert into Rupees.

(The above is a simplistic basic explanation. The prices are also imaginary and are for illustrative purposes only. )

1 comment:

  1. Thank you for the explanation offered.I wish things were as simple as this.The real issue is not the rise and fall of the innternational crude prices or the fall or increase of the Indian currency, though theses two are very important factors.
    The fianal price that we pay at the pump is determined by the taxes levied by the central and state governments, thiese taxes are a significantly large proportion of the final price, and to add to the agony and insensivity the taxes are levied as a percentage of the price and not on absolute cost which means that with every increase the taxes go up disproportionately.
    There is a case for levieing taxes,however most of these taxes go in funding the corrupt politicians corrupt Babus and Non working goverment servants, and holding Political tamashas.What is required is a complete overhauling of the pricing mechanism and pricing policies.We also need to rethink on our over all economic direction and and system of fiscal governance where we steal from middle class and pay for political harakari.
    Aftab Patel