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Can price hikes worsen Kazakhstan’s gasoline shortage?

In the last few months, drivers and observers have suspected gasoline shortages in cities of Kazakhstan, including Almaty.  Shortages may also occur in Kyrgyzstan because of a holdup of petrol supplies from Kazakhstan. 

In June, the oil and gas minister of Kazakhstan, Uzakbai Karabalin, denied that a gas shortage would occur and vowed to avoid a price hike.  (In Kazakhstan, the government regulates retail fuel prices.)  But in late August, the economy minister authorized gasoline prices to rise 10% to 15%, reported TengriNews.  At present, the liter price of high-grade gasoline is roughly 157 tenge, or 86 cents, estimated globalpetrolprices.com. 

The government may have had to raise prices in order to eliminate excess demand.  Question: How should they rise?

Suppose that the prices of all grades of gas rise by the same amount – say, 20 tenge per liter.  Remarkably, this may increase demand for the highest grade of gas, compared to the demand for a lower grade; and it may not alleviate the shortage of high-grade gas as much as that of low-grade gas.

To see how, check out your apples.

Suppose that the city of apples, Almaty, exports its fruit to Moscow.  Every apple sent out will incur the same transport cost -- say, 5 tenge.  To avoid losing money, exporters must raise their price by 5 tenge per apple.  The demand for apples, or for anything else, depends on the price of apples relative to the price of a substitute, since the buyer must decide which product to buy with his 20 tenge.  This especially applies to good and bad apples.  A good apple sells at a higher price than a bad one – say, 20 tenge rather than 10.  In Almaty, the relative price of a good apple is thus 2 bad apples, or simply 2. 

Now suppose that we export both good and bad apples.  The price of both will rise by 5 tenge, or to 25 tenge and 15 tenge.  The relative price of the good apple exported is 25 / 15, or 1.67.  Yes, the relative price of the good apple falls when it is exported to Moscow rather than sold on Dostyk Boulevard.  Consequently, demand for good apples, relative to demand for bad ones, will be higher in Moscow than in Almaty.  Ceteris paribus, the seller may respond by selling good apples in Moscow and bad ones in our fair city.  Have you checked your yabloky for worm holes lately?

Your slimmed-down wallet

Back to gasoline.  If all octane grades increase in price by the same amount, then the price of high-grade gas, relative to the low-grade price, will fall.  Motorists will respond by substituting some high-grade gas for low-grade gas. 

How much will they substitute?  We don’t yet know.  In the United States, studies indicate that a fall of 1% in the relative price of high-octane gas will increase demand for it, relative to low-octane gas, by less than 1%, even after two or three months.  Drivers may be reluctant to substitute one grade of gas for another because their vehicles are designed for a particular grade.  In any event, if these figures hold roughly for Almaty, then a uniform price increase may not aggravate the shortage of high-grade gas by much.

In addition, increases in gasoline prices reduce the purchasing power of your income, since you can no longer buy as much gasoline as before.  As a result, you may buy fewer liters overall – say, 10 liters per month rather than your usual 20.  The share of high-octane gas in your purchases may rise – say, from 10% to 15%.  But because your overall purchases have fallen, the overall amount of high-octane gas that you buy is likely to fall.    

Still, keep your fingers crossed.  You’ll need some gas in order to drive to Moscow and buy good Alma-ata apples. –Leon Taylor, tayloralmaty@gmail.com

Notes

The drop in the price of a good product, relative to the price of a bad one, occurs because a given increase in any number will raise the total by a smaller percentage for a large initial number than for a small one.  This illustrates what economists call the “third law of demand.”  Alchian and Allen introduced the idea. 

In our example, the initial price of good apples was 20 tenge.  The additional 5 tenge due to transport costs raised the price by 25%.  The initial price of bad apples was 10 tenge, which the additional 5 tenge raised by 50%.

References

R. Morris Coats, Gary M. Pecquet, and Leon Taylor.  The pricing of gasoline grades and

the Third Law of Demand.  KIMEP Social Research Working Paper Series.  2014.

globalpetrolprices.com.  Kazakhstan gasoline prices, liter.  Accessed September 2, 2014.

Gyuzel Kamalova.  Additional gas to be imported from Russia: KazMunaiGas Onimderi.  en.tengrinews.ke  September 1, 2014.

Oksana Kononenko.  V KMGO schytaiot defytsyt benzyna delom ryk camyx AZC.  Panorama.  August 22, 2014.

Assel Satubaldina.  Kyrgyzstan blames Kazakhstan for fuel shortages.  TengriNews.   en.tengrinews.kz.  July 11, 2014.

Sergey Smirnov.  Struggle with gasoline shortage in Azerbaijan and Kazakhstan.  Oilnews.kz.  November 27, 2013.

TengriNews.  No petrol shortages expected in Kazakhstan: Oil Minister.  en.tengrinews.kz .  June 19, 2014.

Gul’zhanat Yxyeva and Ol’ga Kym.  Benzyn na korotkom povodki.  Kursiv’.  August 21, 2014.

Good reading

A. A. Alchian and W. R. Allen. University Economics.  Wadsworth. 1967.

    

T. E. Borcherding and E. Silberberg. Shipping the good apples out: The Alchian and Allen Theorem reconsidered.  Journal of Political Economy, Vol. 86. 1978.