Subsidies and Their Relevance

Subsidies are usually given by government to help and facilitate in increasing the quantity or amount supplied by a firm especially on merit goods. Merit goods are goods that will bring positive externalities to the society. External benefits here mean that those who are not involved directly in the production or consumption will be receiving benefits when someone produce or consume a certain goods. For example, when someone consumes health care, he or she will reduce the spread of contagious diseases to the society. The society is said to benefit from this consumption although they did not receive any health care services directly. Back to subsidies, government usually provides subsidies to encourage firms to produce more by actually helping them produce goods at a lower cost.

From the diagram above, we can see that there is a shift in supply curve, which is the upward sloping curve. Demand curve, which is the downward sloping curve, remains unchanged. The initial equilibrium point (E0) is the intersection between demand curve (D) and initial supply curve (S0) with equilibrium price of P0 and equilibrium quantity supplied at Q0. When government supply subsidies, the supply curve will shift from S0 to S1 as the production cost is currently lower which prompted the producers to increase their production. This eventually causes the equilibrium point to change as well as the equilibrium price and equilibrium quantity. Equilibrium point (E1) is currently the intersection point between demand curve (D) and the new supply curve (S1) while equilibrium price is currently P1 with an equilibrium quantity supplied of Q1. When supply increases, price for the particular good will fall. This is due to the reason that supply for the good is relatively sufficient to cater for the demand in the current market. From the diagram, we can also see the amount of subsidies given by the government. It is represented by the dotted line between S0 and S1. This amount of subsidies can be enjoyed solely by the sellers or buyers or even shared between them depending on the price elasticity of supply of the particular good. However, as production increases, there is a misallocation of resources due to the inefficiency covered by subsidy. This is also called the deadweight loss and can be represented by the triangle area of AE0E1. It is a net loss to society because this amount of money could have been used for other purposes such as producing more public goods, or to reduce government expenditure which might lead to a reduction in tax incurred on the people.

Subsidies can definitely benefit people in a way that we actually pay lesser for the goods we consume. This can be really beneficial particularly when we are given the aid in industries such as medical and education fields. However, this may not usually be the case especially when the funds are allocated on certain goods that benefit the rich more rather than the poor. For example, subsidy spent on fuel in the year 2012 is RM42.4bil which is a 17% increase compared to the previous year of RM 37.61bil. Cheap petrol benefits wealthy people in a sense that comparing them driving a fuel-guzzling BMW X5 with a Perodua Myvi most average Malaysians owned, we can clearly see that the percentage of their income used on fuel will be much lower compared to the percentage of income used on fuel by an average or a middle class earner. Imagine someone earning RM100k per month spending say like RM500 on their fuel consumption. The percentage of their income used on fuel is only 0.5%. As for a typical middle income earner, if they earn RM4000 per month and spend around RM200 on their fuel, the percentage is 5% which is way more than the percentage of income spent on fuel by those wealthy people.

Besides that, our subsidy policy actually weakened our independence as the subsidy mentality infiltrates all level of our society. When we talk about subsidy, it should bring an effect where it actually makes us more competitive and efficient as our cost of production is now lower compared to previously. However, what really happens is that once subsidy is provided, people tend to take it for granted and do not use those resources to its maximum capability. Instead, wastage occurs and this ultimately makes us noncompetitive when on papers it should have. One clear evidence, are jackets or sweaters easy to notice in offices? This scene is due to the “never say die attitude” of the air conditioning that keeps us cold or somewhat way too cold. Energies are not used to their potential when they should have been because they are too cheap to some firms causing them not to make it an effort to consume energies wisely. This will further deteriorate our nation’s competency with other countries when they are actively searching for ways or substitutes to minimize energy consumption when fuel prices are high. The diagram below shows how the demand for a substitute good increases when the price of fuel increases. Price of fuel increases from P0 to P1 which causes the quantity demanded to fall from Q0 to Q1. Demand of substitute good on the other hand increases from DD0 to DD1 at the same price level as people seek for a replacement of fuel to reduce costs they have to bear.

These energy saving methods of theirs are currently their strong weapon or strategy to outdo their competitors. They can even make extra profit if the energy prices of global fall as long as demand is inelastic, meaning that the changes in price of energy will not lead to a change in quantity consumed.

Therefore, what Umno Youth chief Khairy Jamaluddin mentioned about the funds spent could be better used is notably true. (Full article can be found here at: http://thestar.com.my/news/story.asp?file=/2012/10/6/nation/12132262&sec=nation ) The first step taken by the government is to remove the 20sen per kg subsidy in sugar from the previous 54sen per kg subsidy. No doubt it increases the burden on the people but don’t we realize something? Lower income people will not spend extra of their income on sugar when they have been subsidized. Instead, they will use it on other purposes deemed more important such as education and health care. Not to forget that the system in subsidizing food items or petrol also benefits the rich people and big company that is supposed to help those in need, particularly those from lower income group. Another arguable matter is that illegal workers or even foreigners are also benefitting from this system. Therefore, it is really an issue the government should look into more thoroughly so as to bring the best out of the intentionally good subsidy.

So, converting the funds into certain other areas like education and medical health centers catered for the poor as suggested by the Umno Youth chief is definitely something we should agree upon as it will no doubt bring benefits to the poor who are still finding it an issue to fund their children to a proper education or sending them for medical assistances when needed. Subsidies on merit goods should definitely be the priority when deciding on which area of goods are to be subsidize so as to decrease the gap between the rich and the poor as well as to help propel the standard of living of the poor in our country.