Fuel Tax on Chinese Oil

The Chinese government previously subsidized energy, but due to a growing strain of paying the subsidy they plan on imposing a tax on fuel, to help them subsidize highways building and become a more energy efficient nation.

According to the article, the Chinese government (along with many other countries) has subsidized energy in the past, in particular gasoline. Subsidies are financial payments given to the producers by the government to reduce costs of their products, in this case fuel. Subsidies increase the supply of fuel because they lower the resource costs of production and both subsidies and resource costs are two determinants of supply*1.

The graph below shows the supply curve shifting down and out which illustrates an increase in supply. The decreases in price due to the subsidy will result in a higher quantity demand of fuel; quantity demanded being how much the market demands at a particular price. The article claims that half the world benefits from these energy subsidies which prevent "rising prices from lowering world demand to the extent that the textbooks say they should when prices rise." In other words, as the Law of Demand states, ceteris paribus, as price falls, the quantity demanded increases showing an inverse relationship between price and quantity demanded.



The Chinese government must take into account the consumers reaction to this sudden tax that will be imposed on fuel, in order to know how much damage it could do for both the producers and the consumers. A consumer's responsiveness to a change in price is measured by price elasticity of demand (PED). An inelastic product would be one to which a consumer would not respond strongly to price changes, so a change in price of an elastic product would result in a strong response by the consumer. To determine whether a product is inelastic or not, one must consider the determinants of PED *2. Fuel has a great deal of uses and few substitutes available, which make it an inelastic product. It is also a necessity as it is almost the only way for vehicles to travel, the only medium to heat up buildings or cook. On the graph below you can see that a great change in the price of fuel leads to just a small change in quantity demanded.

Oil is categorized as an intermediate good, a good used as input when producing other goods. It is not only used for transportation, but also in the production of clothing and plastic amongst other goods, therefore a change in price of oil can have major consequences on a larger scale. All imported goods will be affected as the price of their transportation increases their costs. The soybean market is a specific example of an imported good affected by the soon to come tax. The price and quantity equilibrium*3 before the introduction of the tax is shown is where the supply and demand curve intersect. The tax shows a higher equilibrium price and in result a lower quantity equilibrium. On a greater scale, a vast amount of the products in sale in the country will have increased prices causing inflation which is when the value of money decreases.

The time immediately following a change in price is known as the fixed plant period, and during this time factories can only rely on the capital they own to cut back on their production of fuel, this is point A on the PPC below. In the long run, the variable plant period, firms can adjust to the changes in price of fuel better by allocating their resources towards more efficient energy producing plants, as the quantity demand for oil decreases with the increases of price. The Production Possibilities Curve below shows Chinese reallocation of resources towards wind power for example as it is a substitute for oil, shown as point B.

*1: Determinants of supply influence the supply of a good or service. Supply is a schedule or curve showing how much of a product producers will supply at each of a series of possible prices during a specific period of time.

*2: The amount of substitutes a product has and whether it is a luxury or a necessity are two determinants of price elasticity.

*3: Price Equilibrium is the price where the intentions of buyers and sellers are balanced. Price and quantity equilibrium is driven by the competition between buyers and sellers in the soybean market in this case.