China Increases Fuel Prices

China has decided to increase the price of fuel. This seems like an odd statement to us for two reasons.

1) Markets (supply and demand) determine prices for fuel in the United States (in spite of what many think). Government intervention in markets tend to make consumers and producers worse off. There are a few examples of market failure where government involvement can increase economic efficiency, but most economists believe that if the government gets involved in the fuel market it should be to increase the gas tax to reduce negative externalities (a topic for another day) not to subsidize its use.

2) The Chinese government is raising the price. While politicians in the U.S. climb over each other trying to find a way to decrease fuel prices here, the Chinese government is increasing the price. Why? Speaking economically, the current price in China is below equilibrium (the price determined by market forces). This requires the Chinese government to subsidize the price. The subsidy sends improper signals to consumers and requires massive government revenues. The lower price results in consumers using more than optimal. The massive government revenues required to fund the subsidy might be better used to fund infrastructure, education, assisting earthquake victims or meeting the extreme environmental issues in the country.

The higher price is good for the global oil market. Increased demand for oil from developing nations is one of the reasons oil prices are high. The higher price i n China will result in a decrease in the quantity demanded, relieving some of the pressure on rising prices. The amount by which the quantity is reduced by the higher price is measured by the elasticity of demand, a topic I will take on soon.