Transcript Multi-fiber agreement - Ka

Long Lines, Lost Profits:
China’s Regulated Fuel Market
Ka-fu Wong
University of Hong Kong
1
In a free market, equilibrium price is determined by its respective
supply and demand?
Price
A
Welfare = Total surplus
= Consumer surplus + Producer surplus
= right triangle ABC + right triangle CBD
Supply
B
C
Demand
D
Quantity
2
Suppose the government wants to regulate the price of gasoline
(Note that both retail and wholesale prices are regulated.)
Price
A
By regulating the price below the market equilibrium,
(1) Buyers are encouraged to buy more
(2) Sellers are encouraged to sell less (or discouraged to sell).
Supply
C
Price regulation
(ceiling)
D
(2)
(1)
Excess demand
Hence, there will be excess demand
(i.e., quantity demanded > quantity
supplied). Consumers will line up for
the product. Thus, consumers wind up
paying with waiting time.
Demand
Quantity
3
For the case of China, the regulation not just in the retail gasoline market
but also in the wholesale market from the refiners to retailers. Refiners
are supposed to supply as much as the market demands at the regulated
price, possibly with a subsidy from the government.
Price
A
Consumer surplus = right triangle AHE
Welfare = CS + PS – subsidy
Producer surplus = right triangle DGF
Welfare loss = triangle CEF
Subsidy expenditure = rectangle EFGH
Supply
Supply with subsidy
F
G
Subsidy to the
input price
C
Price regulation
(ceiling) H
E
Demand
D
Quantity
4
Can such price control (with subsidy to input price) sustained in rising oil
prices?
Price
Supply with a higher oil price
A
F’
G’
Supply
G
F
As oil price rises, subsidy
required rises from EFGH
to EF’G’H.
Supply with subsidy
C’
C
Price regulation
(ceiling) H
E
Demand
D
Quantity
5
Oil refinery
Crude oil is separated into
fractions by fractional distillation.
The fractionating column is cooler
at the top than at the bottom so
the vapours can condense more
easily while moving up the
column. The heavier fractions that
emerge from the bottom of the
fractionating column are often
broken up (cracked) to make
more useful products.
6
What is the effect of rising oil prices without a subsidy (or a comparable
increase in subsidy)?
Price
Supply with a higher oil price
A
Supply
C
Price regulation
(ceiling) H
As oil price rises, excess demand rises.
Longer line at the gas stations, and
hence longer waiting time, are expected.
E
Demand
D
Excess demand
Quantity
7
Effect of rising oil price on refinery’s production
$
MC
The firm will continue to produce
as long as P is higher than AVC
although it will be making a loss
if P is lower than AC.
AC
P*
AVC
Quantity
8
Effect of rising oil price on refinery’s production
MC’
$
MC
Higher oil prices will shift the cost
curves upward. If P is lower than
AVC, the firm will shutdown. That
is, no gasoline will be supplied to
the retail gasoline market.
AC’
AVC’
P*
AC
AVC
Quantity
9
Why would a government choose to subsidize the
supply of gasoline?
To protect the poor and hold back inflation, governments across Asia,
including China, have either subsidized fuel prices by using their own
budgets, or worse, kept them low by twisting retailers arms.
- Petroleum Economist, “China: Fuel shortages prompt rethinking on oil pricing”, October 2005
10
Will you recommend the foreign firms to enter the
China’s oil market? Exploration and Production?
Refinery? Retail gasoline market?
 China’s oil industry is regulated. A regulated market is a good market for
those who know how to deal with governments. And, usually a regulated
market comes with protection from the governments as well. That is,
monopoly rent may be ensured.
 Exploration and Production is good because entry is highly regulated and
oil produced may be exported to the rest of the world and sold at world
market price. That is, monopoly rent is ensured once you enter the E&P.
 Retail gasoline market is good because profit is guaranteed as there will be
a fixed markup from the guidance price. Risk-free!! However, competition
may be keen as the market opens up for other participants. Keen
competition may drive up the cost of running the business (including land
cost). When variable cost (such as labor cost) increases, it may further
narrow down the profit margin.
 Refinery is the sector that is heavily regulated. If the output price is
regulated and we fail to obtain subsidy from the government, we will lose
money. The hope is that the output price regulation may be relaxed. The
move towards a free market is likely because it is difficult for the
government to finance the huge subsidy as oil prices rise.
11
The guidance price is revised regularly. Is there a way
to take advantage of the revision?
 If one know that the price is going to revise upward tomorrow, one can
stock up gasoline on the cheap today and sell it on the high tomorrow,
taking into account the storage cost.
 Thus, the regulation of guidance price and the regular revision will invite
strategic behavior from the participants.
12
Why would the wholesalers willing to supply the product to the
retailers at a regulated price (much lower than the free market
equilibrium) even if they received no subsidy from the government?
E&P
Retail
Cross-subsidy
Refinery/ wholesale
Cross-subsidy: A profitable activity subsidizes a loss-making activity in a firm.
13
End
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