Why the hike in fuel prices affects all of us

There are of course, various measures of growth and wealth of a country. But the two common and widely acknowledged measurements are GDP (Growth Domestic Product; where only seen materials are taken into account) and CPI (Consumer Price Index). The former is more common in determining the national income of a nation whilst the latter is used to measure inflation. Ceteris paribus.

Another concept that is vital to this observation is GDP deflator, that is how much does it take to 'deflate' the nominal GDP to become real. The two commonly used indexes to measure GDP deflator and CPI are Paasche and Lespeyres index. Paasche price index (derived from Hermann Paasche, a German statistician and economist) is based on today's prices, and as such form the basis of GDP deflator. The Laspeyres index (also a German economist, Etienne Laspeyres) on the other hand, measure the changes in today's prices based on fixed prices.

I don't intend to ache your head will all these theoretical stuff and thus, so let me simplify these notions in my own words. You use Paasche index to measure GDP deflator, so that you know how much you need to make your nominal expenses become real. On the other hand, the you use Laspeyres indes to determine whether the rise in price today will you make you better or worse off than yesterday. As such, if there is an increase of price in, say, rice, I want to know whether the increase in price is a general trend or rather a relative one.

So lets experiment with a realistic example; the drastic hike in Malaysian fuel prices. Since yesterday, the petrol's price was RM1.92. The government, under the leadership of Datuk Seri Abdullah Ahmad Badawi has decided to rise the price by 72 cents, effective today. Diesel's has increased from RM1.52 to a whopping RM2.52, a shocking 65% increase. The government claims that with this step, the country will save up to RM13.7bn and will use this surplus of funds to subsidise imported rice and cooking oil, among others.

Ok, now lets take a typical Malaysian car, Proton Wira. A Wira usually needs 30litres of fuel for a full tank. So using the old price, a Wira's owner is expected to spend around RM200-300 per month for his Wira (to make things less complicated, let us just assume other things being constant. Ceteris paribus.) But with the new price, he will definitely try his best to fully utilise his journey so that he can reduce his fuel consumption. As such, we would expect his consumption of oil will fall. But is he better off, or worse off than before? This is when Paasche/Laspeyres index becomes handy.

We use Paasche price index first. The notation is given by;

where t_n is the current year and t₀ is the previous year (or base year, for that matter). Ok, I'll create a situation. Bad used to replenish his Wira's tank 5 times per month with the old petrol price. Now, as the price for petrol has increased, he only fills his tank thrice per month. Using this information, we can now calculate his Paasche price index.

P_{(Paasche) = [RM2.70 x (3 x 30litres)] / [RM1.92 x (3 x 30liters)]}

= 1.40625

Using the Laspeyres price index;

and using the same info as above, we can also calculate the index.

P(Laspeyres) =_{[RM2.70 x (5 x 30litres)] / [RM1.92 x (5 x 30liters)]}

_{= 1.40625}

which is the same as above.

So, what do these infos tell us...? Roughly, it suggests that Bad is definitely going to be worst off, as a result of the rise in fuel prices, regardless which index you are using. And haha, get ready! As Bad is a typical average Malaysian, he thus represents all of us. Hence, it also tells us that most of Malaysians will be badly affected by this change in price. Bear in mind, 1.40625 is not a small number, when index comes into concern. It illustrates a rise of 0.40625 from the original value (in other words, an approximate 40% rise in price). Also bear in mind that an increase in fuel prices is not merely trivial. Oil, also known as the 'black gold,' is arguably the most important commodity in today's modern economic world. Hence, a rise in fuel prices will surely trigger the rise in prices of other goods. So now when Bedah goes to her usual mamak stall, she'll find out her roti canai costs 20 cents more than before, because the prices for flour and everything else have increased. Or when Steven Chia wants to buy a new house, the cost now has doubled, probably tripled than a month ago, thanks to the increase in prices of cement, woods and concretes. Letchumy Karupillai also finds out that now she has to spend more on her usual groceries shopping at Giant. All these will inevitably lead to none other than INFLATION.

Oh and don't forget that the price elasticity of demand for fuels is highly inelastic. This means that although there is a sharp rise in the fuel prices, the fall in quantity demanded for fuels is very insignificant; simply because fuels are considered as daily necessity. In fact, the revenue gained from fuels now is even more profitable, compared to before. So... Who gains from this hike? PETRONAS. And who owns it? Ahah! That's a completely different story... *grin*

My mom has already complained about it. She said now my family has to adjust the budget accordingly; cut any unnecessary expenses wherever is possible. Sigh.. And what was Abdullah's response to this? He urged Malaysians to be more modest in spending, to cushion any undesirable effects of the drastic rise in oil's price. Right... I wonder if that also means he will reduce his unnecessary trips to oversea... *ooopppsss*

But again, of course, I am only a student. I am nobody. Whereas Abdullah is the Malaysian Prime Minister. He has all the bright minds and think tanks working all days and nights to ensure the welfare of his beloved fellow citizen. Having said that, the 78 cents increase of the petrol prices and one ringgit for diesel's, must be the best thing to do. He must have considered all the options, thought about all the pros and cons... He is right, I am wrong.

Hahahahahahahaha... *lol*

-gabbana-