Economics

Demand is a schedule or a curve that shows the various amounts of a product that consumers are willing and able to purchase at each of series of possible prices during a specified period of time (McConnell, Brue and Flynn, 2009). Law of demand states that other things remaining the same, the higher the price of a good, the smaller the quantity demanded and vice versa (Sloman, Wride and Garratt, 2012). Figure 1, shows a negative relationship between demand and quantity demanded. There are two reasons causing this curve shape and law of demand. They are substitution effect and income effect (McConnell, Brue and Flynn, 2009).

Figure 1

       

           

Price Elasticity of demand is the measurement of how responsive the quantity demanded of the good is to a change in its price while others remain the same (Sloman, Wride and Garratt, 2012). It is calculated by dividing percentage change in quantity demanded over percentage change in price. If the price elasticity of demand is more than 1, the good has an elastic demand. If the price elasticity of demand is less than 1, the good has a inelastic demand. So, a good with unit elastic demand has a price elasticity of exactly 1.

Elasticity of demand depends on nature of products, in terms of necessities or luxuries. Petrol is a necessity where everyone needs it to carry out daily life. Generally, it has an inelastic demand as everyone needs petrol to live. In Malaysia, price elasticity of petrol is inelastic as quantity demanded is not closely affected by the price of petrol. The price is fixed by government.

                                                                          

                                                                           

                               

Figure 2

            In Malaysia, there is a price ceiling regulation that makes it illegal to charge a price higher than a specified level. It only has effect if the rent ceiling is set below the equilibrium petrol price (RM3.18). The price of petrol is capped at RM 1.90 regardless of the price fluctuation in global market. According to the law of supply, the higher the price of a good, the greater is the quantity supplied while other things remaining the same (Sloman, Wride and Garratt, 2012). So, when the price is below the equilibrium price, the supply would decrease and a shortage would occur.

           

Figure 3

To overcome this shortage problem, government  intervenes by giving fuel subsidy. Subsidy is a payment to a producer from the government, usually in the form of cash or tax reduction (Miller, 2008). Gas stations are not allowed to sell petrol at any price higher. So to fill up the price to market price, government subsidize the rest of the remaining cost, subsiding RM1.28 per litre for RON 95. This shifts the supply curve right, from Sdomestic to Sdomestic+ subsidy, increasing supply from Q1 to Q3, solving shortage. In  Malaysia, subsidy is given to an extent that there is no shortage for petrol as an oil producing country.

Oil Subsidies by the Government Jun 2012
	PETROL RON95
	RM / litre
Real price	3.18
Controlled price	1.90
Government subsidies	1.28

Figure 3

[Source: Asia One, 2012 ]

Even under controlled pricing, a competition still forms between firms. It is an oligopoly market. Number of firms are a few but all in big scale (Tucker, 2008). The freedom of entry is restricted as it is difficult to set up a big oil station company in Malaysia. Product- petrol is a homogenous product, but the firms differentiate themselves from one another through their services and branding. For customers, it is the same for where they pump their petrol. So, their choices which reflects demand depends much on their taste and preference. It depends much on the service of the firm. Sales of their preferred gas station would likely have a higher market share. In Malaysia, there are a few dominant players like Shell, Petronas, Caltex and others (Malaysia Central) .

 (Source from : James Keyser/Time & Life Pictures/Getty Image, 2011)

Figure 4

In most of the states in the United States, there is no price regulation. The petrol price varies with market price. Figure 4 shows different gas station selling petrol at different prices. They are in a perfect competition market. The number of firms in this market is big and there is no barrier to entry. The product-petrol is homogenous. Both buyers and sellers have equal access to information, so firms are price taker because the equilibrium price is determined between the market supply and market demand (Miller, 2008). The price elasticity of demand is higher and more elastic than in Malaysia as customers are more price sensitive. When one station has a lower price, the sales of other gas station would likely drop and vice versa.

Although they are in a perfect competition market, there is small deviation on petrol price for each firm. There are other factors affecting the difference of price at different gas stations. Each gas station's branding carries different price effects. It differentiates one' price from another. Premium brands such as Exxon, Shell, Mobil and others would usually have a higher petrol price compared to unknown gas station. Most of the petrol stations have two different services, self serve and full serve. Full serve charges more with the service of cleaning vehicle's windscreen and checking vehicle's engine oil levels and radiator water (Cletheroe, 2006).

Location of the gas station decides the petrol price. Gas stations which are located in cities or high way would normally charge petrol at a higher price due to slightly more inelastic demand in these areas. For island like Hawaii has the highest prices as it includes all the transportation expense from mainland to there.

(Source from : AAA, 2013) Figure 5

In Malaysia, the demand for petrol is inelastic as the price is lower than market price due to the implementation of price ceiling and subsidy. There are a few advantages of the implementation of price ceiling and subsidy. People get to enjoy the petrol price which is below the market price. It improves social welfare (Elis, 2010). It also prevents formation of cartel, price discrimination and controls the percentage of revenue firms generated relative to sales.

However, there are a few disadvantage of use of price ceiling and subsidy. Because of the huge amount spent in subsidy, government would exert more taxes or expenses on other goods or aspect to ensure the money flow (Widodo, 2012). This might be another hidden burden for people. Government would have an inefficient of budget. Time frame for this subsidy would be infinite. Government can take off subsidy without prior notice.

Furthermore, when government implements price ceiling, the oil industry would be less competitive. The market would never reach an efficient level as marginal benefit exceeds the marginal cost when price is controlled (Taylor, B, 2006). A deadweight loss would occur. This mechanism causes fuel industry in Malaysia not becoming a potential industry for investment as there cannot be a change in price. Free trading is restricted and this is not a good sign for economic growth as a stiff competition is needed to develop and grow the economy of the country. A price ceiling also causes the smuggle of petrol in Malaysia. Smuggling is to export or import without paying lawful customs duties (The Free Dictionary, 2013). This can be reflected through news of petrol smuggling into neighbouring countries (The Star, 2012).

In the US, the demand for petrol is slightly more elastic as price changes all the time. Price of petrol varies the market price. Time elapsed since price changes is one of the determinants of elasticity of demand. When there is more time for consumers to adjust to a price change, the more elastic is the demand of the good (Sloman, Wride and Garratt, 2012). To gain more benefits while the petrol price is low, some may even buy petrol for storage. Demand of petrol is affected by expected future price. When the price of the good is expected to rise in the future, current demand for the good will increase, shifting the demand curve to the right (Sloman, Wride and Garratt, 2012).

They implies free trading where no price control is imposed. Free trade improves the production efficiency. The resources are allocated more efficiently and this increases productivity and total output of goods and services (Edge). It makes the market competitive, higher efficiency in production, and innovation (Taylor, 2006) .

Sources from: The World Bank, 2013
Figure 6

To offset the negative effects bought by price ceiling, it is recommended that Malaysia impose fuel subsidy removal. The low price is meant to benefit the lower-income earners and lighten their burden. So, instead of subsidizing the whole market, government can choose to give subsidy or incentives only to the lower-income groups. This can solve social problems besides minimizing effects. It also brings environmental benefit as public would be more thrifty in using petrol (EPA).

For the US which is a free-trading market, the government can also give petrol incentive to firms when petrol price reaches its highest point, beyond market's expectation. This move get to take good care of people' welfare and give firms a push to boom the economy.

In conclusion, although both countries' petrol prices are relatively low in global market, the price elasticity of petrol demand in the USA is higher and more elastic than in Malaysia. In Malaysia, people are more encouraged to pump petrol than in the USA due to the lower fixed price. But, both countries oil industry are good as there is a consistent supply of petrol and no big inflation in petrol price, unlike in other countries. People in both countries generally gain more benefits in term of petrol  than most of the countries.

Referencing List

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