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Transport costs, fuel prices & trade

As fuel gets more expensive the transport costs associated with international trade get larger and trade diminishes. By how much? Paul Krugman cites a study (by Nuno Limão and Anthony J. Venables) that deals with transport costs and geography as factors determining trade. It implies that a doubling of fuel costs will contract trade by 45%. Current fuel price hikes if sustained would reduce trade by 17%.

Of course such significant reductions would reduce the demand for fuels and have the general equilibrium effect of reversing the price increases.

Much the same effects apply to reductions in the demand for long distance travel induced as a consequence of higher fuel costs.

It is certain that the direct initial effects of a fuel price increase will dominate offset effects that reduce fuel prices. This means that from the viewpoint of travel and trade the world is getting bigger.

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