Subsidy of Petrol

According to the news from The Star, "The Government will continue allocated subsidy for RON95 petrol despite fluctuation in global fuel prices, said Domestic Trade, Cooperatives and Consumerism Minister Datuk Seri Ismail Sabri Yaakob." 

The three types of petrol in Malaysia are RON95, RON97 and diesel. As the price of petrol is unstable, Malaysians always have to burden the “risk” of the changeable price on petrol. The government will continue to subsidize for RON95 petrol and the price of RON95 petrol will remain constant at RM1.90 per litre even if the global fuel prices were to increase.

The Malaysian government has cap the petrol price of RON95 at RM1.90, any excess amount will be absorb by the government. Since RON95 is a controlled product, then the sellers are not allowed to sell price above RM1.90. Petrol is price cap but the excess prices are subsidized by the government. Hence, the suppliers will not lose out. Since the suppliers will not lose out, the supplies are encouraged to maximize the sales since it is a supply-side subsidy. Supply-side subsidy means that the government allocated the subsidy for the suppliers instead of the consumers.

Petrol is an inelastic good, as the price will not have much effect to the quantity demanded. Percentage change in price is less than the percentage change in quantity demanded.  The percentage decrease in the quantity demanded is less than the percentage increase in price. Consumer will still demand for petrol as petrol is a necessity to people who owns a car, but people may not use more petrol. Hence the price elasticity of demand is less than one but greater than zero.

The government will allocate a certain amount of money from taxes to reduce the price or maintain the price for the goods and services at equilibrium. When government subsidizes more on petrol, the quantity demanded of petrol will not be affected. However, this affects the price of the other commodity, goods, services and taxes. The disposable income will be reduced. With the high tax rate, disposable income will be reduced, one will not be able to buy as much as desire. For examples, the car taxes will increase. Once the taxes increase, the price of car will also increase. Thus people will not be able to afford to buy a car with a high price and the quantity demanded will decrease. Hence, the demand curve of the car will shift to the left. In additional, petrol subsidy increase but it does not mean that the quantity demanded on petrol will remain the same. It will still have some slightly changes on it.

As the quantity demanded of car decreased, it will affect the change of demand of the petrol. We measure the influence of a change in the price of a substitute or complement by using the concept of the cross elasticity of demand. The cross elasticity of demand can be positive or negative. It is positive for a substitute and it is negative for a complement. An increase or decrease of price of complement goods will causes the change of the demand curve of a certain good, either shift to the right or to the left. Cars and petrol are complements goods. In this case, it is negative and it will cause the demand of petrol decrease and then the demand curve will shift to the left.

When the income of an individual’s increases, the quantity of demand will also increase. The quantity demanded for petrol will decrease when the individual’s income falls. The government gives subsidy on petrol; it will affect the price of other products and services and also the income of people. As the price of goods rise and the income decrease, the quantity demanded on goods will then reduce too. This is because people could not afford to buy products and services which is in a higher price than before; their power of buying thus will decrease. Back to the topic, the quantity demanded of petrol will decrease due to the reduction of individual’s income. There will be a movement along the demand curve. This also shows that petrol is a normal good to the people as the change of the quantity demanded is greater than the change of income.

We already know that the relationship between the cars and petrol are complement. The change of percentage of the price is greater than the change of percentage in quantity demanded. When there is an increase on price of petrol, the quantity demanded for car will decrease. Another way to say that, the raising in price of cars will affect the quantity demanded for petrol decrease. The quantity demanded will move along the same curve. Other than that, the demand of petrol is greatly influenced by the substitution effect. When the price of petrol increase, people will try to look for an alternative source of energy to power their car. As an example, more and more people are changing their cars to hybrid cars that use a mix of two different energies. The increasing number of the hybrid cars in Malaysia indicates that the demand of petrol is starting to decrease. This has a huge impact on the petrol industry in Malaysia.

Since people cannot afford to buy a car, they will choose to take public transport. Public transportation then become as a substitute of cars. When the price of car increases, the quantity demanded of public transport will also increases. This is called crossed elastically demanded. Hence the demand on public transport will increase and the demand curve will shift rightward to a new demand curve. The cross elasticity of demand is positive.

In Malaysia, as there is a high number of poverty, it is essential that the government subsidies staple goods so that the poor is able to live more comfortably.

*Random fact: Oil (petroleum) was formed more that 300 million years ago.

By Wong Min Yiang