A:

In order to make the price of oil more affordable to its citizens, governments sometimes provide subsidies, which can allow the price of oil to remain fixed below free floating market rates. For example, in May 2008, Venezuela was heavily subsidizing oil, allowing its citizens to only pay $0.05 per liter, whereas most Western countries pay costs in excess of $1 per liter (or $3.80 per gallon). However, if oil prices increase, countries that heavily subsidize oil prices may suffer, because the cost of the subsidies will start consuming ever-larger amounts their budgets. This could lead to money being taken away from other areas of public funding, such as social programs and infrastructure.

Similarly, this effect will be magnified by the fact that the demand for oil in these countries will tend to remain stable, or even grow, because the lack of change in fuel costs fails to provide any incentive for citizens to reduce their consumption. Eventually, the government will have no choice but to slowly remove the subsidy in order slowly lessen the public's demand for fuel, although doing so is likely to result in some civil unrest.

On a global scale, many of the countries that use subsidies are emerging countries, which need the cheap fuel to power their fledgling industries. However, if these subsidies are still in place over the long term, the price of fuel will grow even higher as the hunger for subsidized fuel grows in emerging countries, regardless on how much demand for fuel drops in Western countries.

For related reading, check out Why You Can't Influence Gas Prices and Getting A Grip On The Cost Of Gas.

RELATED FAQS

  1. How does the price of oil affect Venezuela's economy?

    Learn how the price of oil has a direct relationship with Venezuela's economy. High oil prices result in good times for the ...
  2. What does marginal utility tell us about consumer choice?

    Learn how marginal utility influences consumer choice under the law of diminishing marginal utility and consumer decisions ...
  3. How does the role of Medicare/Medicaid affect the drugs sector in the U.S.?

    Read about the impact of Medicare and Medicaid on the drugs sector in the United States and how some doctors get rich by ...
  4. What are some common ways product differentiation is achieved?

    If you would like to differentiate your product from the rest, there are a few basic steps you need to follow.
RELATED TERMS
  1. Duty Free

    Goods that international travelers can purchase without paying ...
  2. The New Deal

    A series of domestic programs designed to help the United States ...
  3. Smart Traveler Enrollment Program

    A service of the U.S. Department of State that lets U.S. citizens ...
  4. Separation Of Powers

    An organizational structure in which responsibilities, authorities, ...
  5. Nordic Model

    The social welfare and economic systems adopted by Nordic countries.
  6. Economic Justice

    Economic justice is a component of social justice. It's a set ...

You May Also Like

Related Articles
  1. Economics

    How does the price of oil affect Venezuela's ...

  2. Professionals

    Are These the 10 Best Stocks in the ...

  3. Fundamental Analysis

    Vice Can Be Nice: 4 Sin Stocks to Consider

  4. Economics

    3 Possibilities If Sanctions Against ...

  5. Investing Basics

    How does the role of Medicare/Medicaid ...

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!