Sep 29 2009
Letting markets work: the Malaysia fuel subsidy goes bye bye
Published by Jason Welker at 9:50 am under
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WikipediaThis article was originally published on June 9, 2008
Asia Sentinel – Malaysia cuts fuel subsidy
One of the recurring themes of this blog is the conflict between good politics and good economics. Most of the time in government, smart economic policy is sacrificed in order to achieve political favor with voters. Whether it’s price ceilings on petrol in China, Zimbabwe’s slashing of food prices, harmful import restrictions to benefit domestic producers, or the proposed suspension of gas taxes in a time when fuel conservation is really what’s needed, politicians often act in economically stupid ways to bolster or hang on to their popularity.
So when a government makes a bold move that is economically sound, it sometimes comes as a surprise, as in the case of the Malaysian government this week. The government in Kuala Lumpur has for years subsidized domestic fuel prices, which at under 2 Malaysian Ringit per liter have been the equivelant of roughly $2.40 US per gallon, far below the average price in the west. Drivers benefited from this subsidy, but were not forced to bear any of the burden of rising oil prices, nor had they any incentive to conserve or switch to more fuel efficient automobiles or alternative forms of transportation. The Malaysian government, on the other hand, has had to allocate more and more of its limited budget towards subsidizing petrol prices.
Well, as of yesterday, all price supports for petrol are cancelled, and the effect will be sweeping in the Malaysian economy:
The government announced Wednesday evening that petrol prices would rise by 78 sen (US24¢) at midnight — a 41 percent jump from RM1.92 per liter to RM2.70. That means those spending RM2,000 per month to fill the tanks of their BMWs will now be paying RM2,820. Regardless of income levels, it is likely most Malaysians will feel the pinch.
The subsidy would have cost the Malaysian government 56 billion ringit (around $17 billion) this year. With the money it will now save by ending the subsidy, the government will begin making public transport cheaper and more convenient for commuters who wish to avoid paying for the more expensive petrol to fuel their personal automobiles:
The government hopes to channel the savings into improving public transportation, as it promised many years and elections ago but with little to show. In Kuala Lumpur, despite having a light rail train service and monorail, public transportation is expensive and inconvenient. Worse, intercity travel is still being serviced by old and slow trains, and accident-prone buses.
Malaysia is not the only country taking measures to end government fuel-price supports:
Indonesia has hiked fuel prices by an average of 29 percent, saving about 34.5 trillion rupiah and kicking off a series of street demonstrations… Similarly, after slashing subsidies, Taiwan will distribute US$659 million to middle and low-income families. The latest to raise oil prices is India, whose government announced Wednesday that gasoline and diesel prices will increase by 10 percent.
Price controls and subsidies distort market demand. In Malaysia, where a government subsidy kept the price consumers paid around 2 RM, the quantity demanded exceeded the free market quantity. With the removal of the subsidy, consumers will respond by driving less, reducing overall quantity demanded for petrol. As other Asian nations follow suit, global quantity demanded for petrol will decline, while higher prices incentivize producers to increase output. New prouction facilities will come online, just as drivers begin to find alternative ways to get to work, either through carpooling, public transportation, cycling or walking.
The combined effect of slowing increases in demand (or perhaps even a decline in demand if enough substitution of alternative forms of transportation takes place), and increases in supply as new production facilities come on line will be a stabilization and eventual fall in the price of oil.
The future fall in oil prices is explained in more detail here. Malaysia’s repealing of the fuel subsidy is one example of how markets work to restore equilibrium in a market such as that for oil today, where short-term bubbles always burst. $135 oil is probably not here to stay, if only the market is allowed to works its magic.
Discussion Questions:
- Why does a subsidy create disequilibrium in a product market like the petrol market in Malaysia?
- Give two examples of how consumers may respond to the 40% increase in petrol prices once the subsidy is removed in Malaysia.
- How could making fuel more expensive to consumers in the short-run actually lead to a fall in oil and fuel prices in the long-run?
About the author: Jason Welker is a teacher at Zurich International School in Switzerland, where he teaches Advanced Placement and International Baccalaureate Economics. Jason was an international school student in Malaysia before studying economics at Seattle University then earning his Masters in Education. He calls Seattle and Northern Idaho home. In addition to maintaining an economics wiki and this blog for economics student and educators, Jason also gives presentations on using Web 2.0 tools in education at workshops and conferences around the world. His economics wiki won the 2007 "Best Educational Wiki" award from the "EduBlog Awards". Related posts:
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Petrol price had gone up. Everyone knows it. So many desperate fellows actually drove their cars bumper to bumper queuing in lines just to get their tanks filled last night hoping to save some money before the super price hike. I am no MBA or economist, so I am in no position to fully understand the fuel subsidy thing and their effect on the economy and blah blah blah. But as a normal citizen who has an almost properly functioning brain, I can tell you that the currently planned method of cash rebate is a piece of shit that could only come from someone with shits in their heads.
Reasoning:
1) How many cars are over 2000cc?? Few or may be very few only. Meaning that many (rich or poor), will still benefit from the cash rebate irrespective of their gas using habit. This is not what we want. We want the poor to receive more.
2) Let say I am a businessman who runs a car rental service and I own 50 cars for rental. I rent the car to customers and customers fill and pay for the petrol themselves, so essentially I will receive $31,250.00 ($625.00 x 50) annual cash rebate for doing nothing, extra profit from the stupid policy maker and government.
3) Let say I am a filthy rich man and I own 5 luxury cars but all are below 2000cc, or may be I am just a rich man who likes to own nice cars, then I will be entitled $3,125.00 ($625.00 x 5) annual cash rebate despite being filthy rich with overspending lifestyle while my fellow poor neighbor who owns a Honda 70cc kap-cai only receive $150 annual cash rebate despite being poor and living a thrifty lifestyle!!! VERY STUPID GOVERNMENT!!!
4) Let say I am a poor man who don’t own any cars/motorbike and I rely on public transportation to go to/from work, then I will not get anything sumore I am likely to pay more for transportation fares due to the diesel hike, despite me being very poor not even capable of owning a motorbike, being nice for using public transportation thus relieving road congestion, being environmental friendly by not burning fossil fuels, but in return I get punished!!!! DAMN STUPID GOVERNMENT!!!!!
5) And lastly can the uncle-uncle and auntie-auntie at the POS offices handle the sudden surge in demand for counter services as a result of the cash rebate?? Judging from the services and experiences I had with those uncles and aunties, I don’t think so!
Anyway, I am not all critics and no help. My suggestion is why not implement the rebate in the form of income tax relief/rebate base on income level?
A subsidy creates a disequilibrium in the petrol market in Malaysia because it increases supply and the supply curve shifts outwards, away from the equilibrium. Therefore, the quality demanded increase because the price of gas decreases. Without the subsidy, the market would move to the equilibrium.
There are several things that the Malaysian people would do after such a high increase in gas prices besides demonstrating of course. First of all, it will cut down driving. Secondly, the Malaysians will start using Public transportation. Another thing, they may do is going to a neighbouring country, such as Singapur, and buy enough fuel for the next few months at the market price in Singapur.
By making fuel prices rise and foring consumers to pay more in the short-run, the market would react by a decrease in quantity demanded. Hence, the equilibrium would move down the demand curve in the long-run causing prices to drop.
Subsidy created disequilibrium in a product market, as competition cannot occur, and thus, prices always stay as the government dictates. This however, does not take into account any shifts in demand or supply: for example if people start receiving higher incomes, the price of a product should increase, whereas if the contrary happens, they should decrease. Thus, in this case it proved proficient for the people in Malaysia, as the price they had to pay for oil was lower than the actual price they should have paid, but the opposite could also have happened, where the price people have to pay is too high. Thus disequilibrium is created, making demand either too high or too low.
Malaysian oil consumers could respond to the increase in the prices of oil either by using their car less, using more public transportation (even though the quality is not great) or buying other cars which use cheaper, and possibly renewable, oils. Otherwise, they could also adapt to this change by moving in cities, where cars are not needed very much, since one could handle work and other things just by walking and thus stopping using the car.
Because fuel is now more expensive less people are going to buy this good. Thus, there will be less demand for it (in a Demand Curve, there is an inverse relationship between price and quantity), which will make the supply levels go down in the future to adjust to the new demand. If supply and demand both decrease, the two lines will then meet again at a new point, lower and thus will make the prices and quantity demanded and supplied less at the new equilibrium.
A subsidy is an injection into the economy from the government. Any kind of injection, including loans and investments, will cause the economy to be unbalanced. Only if the sum of the injections equals the sum of the leakages, then the economy will be in a stable state of equilibrium. Since, the Malaysian government has been subsidizing fuel too much; it has affected the economy negatively, since not enough money was spent in other industries and in the society, counting public transport. Thus, the large subsidy from the Malaysian government will create disequilibrium in the petrol market.
It is not very easy to respond to a situation like this in a country like Malaysia, where it is not convenient to take public transport. In my opinion, Malaysians would continue to use their cars and just accept the fact they have to spend a larger amount of their income on petrol. However, two things that Malaysians could do is to either move to a different country, where petrol is sold at a much cheaper price or look for another alternative. For example, people who don’t travel a long distance to go to work or to school might want to purchase a bicycle or just walk a lot more than they normally do.
Since, the price of the fuel increases, the quantity demanded for the product will obviously decrease, since that is stated in the Law of Demand. However, this is a very bad outcome for the Malaysian petrol industry, since their revenue will decrease by large amounts. However, in the long-run the quantity of petrol would increase, since less of it is being purchased. In order to have a stable petrol industry, the firms might have to decrease their price again, since they will have the usual supply and will lead to an increase in demand until both demand and supply are the same, which will signify the new equilibrium of the petrol industry.
This is because the government is inserting extra money into the market so that the people can use fuel without feeling the economic pinch that the rest of the world has been feeling. This has therefore created a disequilibrium because the government has been inserting money into the market but with no income coming back because they are all investing it into something that will benefit the people but they will not be feeling the economic hit and therefore will continue paying their regular price that they have always been paying.
If the price of fuel increases then this will give people the initiative to either start using public transport much more and with the government rerouting all the funds that they were giving to the petrol market to the public transport market, I believe that this is what the government of Malaysia hopes to happen. There is also another choice in that people will start buying more fuel efficient cars and selling all of their older inefficient cars or that they will stop using cars in the first place at all and start using bicycles or maybe just walking.
More and more people will want to move to other modes of transport as the subsidy is taken away. Once this happens, however, people will sell but their cars or rethink their financing ways in order to find the least expensive mode of transport. Since this change will also mean that public transport will become more efficient and less expensive because of the increase in prices of petrol then people will start using the public transport and then when the gas prices reduce once more public transport will have changed many Malaysian lives in that they will continue using public transport instead of deciding to go back with the car.
Correction to my first post after reading the text: …but the opposite could also have happened, where the price people have to pay is too high if a minimum price above Pe had been set by the government.
If a subsidy is given to a firm for a certain product, in this case petrol, then the supply curve for the product will shift vertically downwards by the amount of the subsidy, because it reduces the costs of production for the firm, which means that the firm can supply more of the product. Disequilibrium occurs because, since the government is intervening, the free market does not work as it otherwise would, which means that there is no competition between petrol firms, which means that equilibrium between supply and demand will not occur.
When the petrol prices increase due to the removal of the subsidy, the consumers in Malaysia will respond by using their car less, buying a car that uses less petrol, or using more public transportation. It is very likely that people will start using public transportation more often, since the government was planning on lowering the price for that, which will encourage people to travel publically rather than with their cars.
Making fuel more expensive to consumers in the short-run would lead to a fall in oil and fuel prices in the long-run because the demand of oil will fall as the price increases. Therefore, less oil will be supplied because the demand has decreased. This will lead to a new equilibrium which is lower than what it was before the government interfered.
A subsidy creates disequilibrium in a product market because the actual relationship between price and supply and price and demand can’t take effect. The price of petrol seems lower to customers, which is why more quantity is demanded, but the supply can’t keep up with the high quantity demanded. The high quantity demanded would, without government intervention, cause the price to rise and therefore the supply to rise, which would then be equilibrium.
With a 40% increase in petrol prices customers will a) drive less (consume less petrol) and b) look for alternatives to driving (public transport).
Making the fuel more expensive will cause a fall in quantity demanded, which could then even lead to a decrease in demand if alternatives (substitute goods) are preferred to driving. The high prices will, on the other hand, make firms be able to increase their output, and so the quantity supplied will increase. A lower demand and higher supply will cause a fall in fuel prices.
A subsidy creates disequilibrium in a product market because the seller/ supplier has more money to produce and to pay costs. Therefore the supply increases, meaning it goes away from the equilibrium and the quantity demanded increases as well.
If you now take away that subsidy, the fuel supplier will face a drastic change: less buyers, less profit, more costs. In some cases, it will ruin the supplier/producer.
Normally, consumers would probably switch to public transport, but in Malaysia it would probably be even more expensive and the quality is pretty bad. So therefore, the consumers would probably just accept the high prices and pay them. But, it is possible that they would switch to cars that use less fuel which would then lead to a better and healthier environment.
Sellers would have to compete with each other in order to attract more buyers. Buyers are likely to buy the cheapest fuel, so every seller needs to go further down with the price as his rival: COMPETITION. So therefore, in the long-run fuel prices will fall.
1. Why does a subsidy create disequilibrium in a product market like the petrol market in Malaysia?
A subsidy creates disequilibrium in a product market because if the price of a certain product goes down people will start to buy and demand more of this product resulting in a shift of the quantity demanded to the right and so resulting in disequilibrium.
2. Give two examples of how consumers may respond to the 40% increase in petrol prices once the subsidy is removed in Malaysia.
- If the consumer sees that the petrol prices have increased by 40% they might start to think if they want to keep on driving their car and not better change to public transportation. This would so result in a demand for more public transportation and a decrease in the demand for petrol.
- Consumers might want start buying cheaper cars because of the high prices of petrol and so resulting in a decrease in the demand for expensive cars and an increase in the demand for cheap cars. Many luxus cars firms might eventually have to shut down their firms.
3. How could making fuel more expensive to consumers in the short-run actually lead to a fall in oil and fuel prices in the long-run?
Making fuel more expensive to consumers in the short-run and actually lead to a fall in oil and fuel prices in the long-run could happen because the suppliers might recognize the decrease in the demand of fuel and so want to make the fuel prices cheaper for the consumers to eventually increase the demand for fuel.
A subsidy creates disequilibrium in a product market because the relationship between supply and demand becomes unbalanced. When looking at this case, the price of petrol appears to be cheap in the eyes of the consumers, which causes the demand to rise. In response, the oil firms can’t keep up with the high demand and therefore lack in supply. Without the governments help, the oil price would raise and the firms now have the chance to provide the needed supply. This way, there would be a stable equilibrium.
Consumers may respond to the 40% increase, by making more usage of public transportation, which would cause public transportation companies to raise their ticket prices.
Making fuel more expensive to consumers would cause a decrease in demand. Due the low demand, the income and profit gained by the oil firms will also decrease. In order for the oil firms to cover their costs, such as wages and rents (factors of production), the companies will be forces to decrease the price of their product in order to sell more.
1. Subsidy creates disequilibrium in a product market like the petrol market in Malaysia because when the demand of gas decreases the quantity demanded increases. Therefore the supply of gas increases and so the supply curve shifts to the right, which creates disequilibrium.
2. When petrol prices increase by 40% once the subsidy is removed in Malaysia, consumers might start to use public transportation which would cause an increase the demand for public transportation and a decrease in the demand for petrol and consequently a decrease in the vehicle market. Consumers might also stop buying cars or switch from a big car to small car which are fuel efficient and therefore cheaper. This would also lead to a decrease in the car market mainly for big cars.
3. Since an increase in the price of oil leads to a decrease of the demand of oil, oil and fuel prices will fall in the long-run. Therefore, the supply of oil will decrease because the demand decreased.
If in a market the government is subsiding the petrol costs to keep them low then the demand will slowly increase since more is needed in production. The demand will increase but the supply will stay constant the consumers are unaware of this and an excess demand will be present, meaning there is more being demanded than supplied. No competition is also present because the price has stayed constant. However, the Malaysian government has not though their subsidy out; they have spent, around $17 billion to keep the price low, which they could have used, for example, for the infrastructure. The opportunity cost of subsidizing petrol would be not being able to improve the infrastructure.
As an alternative to buying high priced petrol; Malaysians could possible take public transport or travel by bike or on foot. Public transport usage would increase if the petrol prices rise because not many Malaysians would want to suddenly pay for the petrol that had just become 40% more expensive. Another alternative to petrol would be by bike or on foot. This might be more time consuming but it would save the petrol indent in your income.
According to the Law of Demand, as the price increase the quantity demanded will decrease. This has recently happened in Malaysia. Many firms will realize that their price are not affordable for many consumers thus they will have to lower their price to get consumers to buy their petrol. So, in the short run the price will increase due to the removal of tax subsidies, in the long run, the prices will decrease because not enough is demanded.
1.Why does a subsidy create disequilibrium in a product market like the petrol market in Malaysia?
A subsidy creates disequilibrium, because if the demand decreases the quantity demanded increases and so it would be a shortage in the quantity demanded.
2.Give two examples of how consumers may respond to the 40% increase in petrol prices once the subsidy is removed in Malaysia.
Once the subsidy is removed and the price for petrol still is high, the consumers will change to public transports, such as trains, trams and buses nstead of using their cars.
Or they would go with a bicyle or they would walk, if the opportunity cost to lose money for the petrol would be less then walking the way to work.
3.How could making fuel more expensive to consumers in the short-run actually lead to a fall in oil and fuel prices in the long-run?
If the price increases the demand will decrease, so the supply will decrease as well, therefore they will fall in a long-run. Because i the price goes up the quantity demanded decreases and after a while also the supply, becaus their will be a surplus.