Nov 01 2007

Beijing caves in to the indisputable power of the MARKET!

Well, not exactly, but that’s kind of a dramatic headline, isn’t it? The other day I blogged about the shortages experienced in the petrol market in eastern provinces, evidenced by the long queues at gas stations around Shanghai last weekend.

Petrol stations resorted to rationing their product in small doses (between 20 and 40 litres) as the price of oil hit $92 and Chinese refiners scaled back production due to rising costs that they were unable to pass on to their customers. Beijing had previously imposed a price ceiling on fuel in an attempt to keep inflation low and Chinese consumers content; the actual impact of this price control was predictable: not enough fuel to go around as the quantity demanded exceeded the quantity supplied, leading to shortages and rationing at the pump.

Well, it looks like Beijing is finally catching on to the flawed nature of their iron fisted attempts at overpowering the forces of the free market, sort of:

FT.com / Asia-Pacific / China – China pushes up fuel prices

“China raised the price of petrol and diesel by almost 10 per cent on Wednesday as crude oil prices hit a record above $94 a barrel.

The move, the first increase since May 2006, came in spite of a promise by Beijing not to put up state-controlled prices before the end of the year in an effort to keep inflation at bay.

Inflation in China exceeded 6 per cent in the third quarter amid rising food-price increases that some fear could lead to social unrest…

The retail price rise in China could stimulate demand in the short term as refiners resume production, and is unlikely to dampen long-term demand, analysts said.”

That last sentence seems strange to me. In what scenario that we have studied would a price increase ever “stimulate demand”? I suspect what the article means is that the price increase will “stimulate supply” as refiners (the producers of fuel), are now able to sell their output at a higher price (or marginal revenue), meaning that the profit maximizing level of output is greater, or higher along their marginal cost curves.

So, output should increase in the fuel industry, which means there will be more fuel for consumers to buy. But surely consumer demand will not increase; this seems to defy the law of demand! What does seem likely, however, is that the higher price (essentially a less restrictive price ceiling), will increase the quantity supplied, thus increasing the amount of fuel available for consumers to buy, alleviating the shortage and allowing Chinese to consume a greater quantity than when the price ceiling was more restrictive.

In fact, the quantity demanded will go down (as the higher price leads to leftward movement along the demand curve), but the quantity consumed will go up (as the higher price leads to a rightward movement along the supply curve). A shortage is being alleviated, but probably not eliminated, considering the price of the raw material in fuel (oil) has increased 40% in the last year, while the price of fuel has only increased 10% since May of 2006. It seems likely that the government set price is still an effective ceiling, meaning there is still excess demand, and therefore we may be seeing more lines of blue trucks around Shanghai in the future!

Powered by ScribeFire.

2 responses so far

2 Responses to “Beijing caves in to the indisputable power of the MARKET!”

  1. [...] Beijing caves in to the indisputable power of the MARKET! [...]

  2. Helenon 11 Nov 2007 at 1:05 am

    I have a few questions. What caused the rising costs for Chinese oil refiners? Is the P = MR rule a unique characteristic pertaining only to perfect competition? Because if that is the case, then the oil industry in China would be perfectly competitive as the blog post stated that P = MR in this industry. But wouldn't it be more like an oligopoly? Because there are only so many oil suppliers (unlike the VERY large number of small firms in perfect competition) differentiating their product through their brands.

    From where I stand, I see the Chinese government facing a lose-lose situation. If they don't establish a price ceiling, the increase in the price of oil would contribute to China's inflation, which is bad. If they do establish a price ceiling, there is then a shortage, which is also bad due to the efficiency loss.

Trackback URI | Comments RSS

Leave a Reply

You must be logged in to post a comment.