Time to revise subsidy for cooking oil?

Based on the article that I selected from Star Online, http://biz.thestar.com.my/news/story.asp?file=/2012/10/2/business/12110226&sec=business, the government had distributed certain amount of subsidies towards the price of the cooking oil. The amount of subsidies is more than RM 1 billion and the subsidy for 2013 will be slightly decreases to RM 1.5 billion. The subsidy distributed by government had started since 1992 as price of crude palm oil (CPO) was trading between RM1,700 and RM2,500 per ton. The oil palm plantation players will take an action when the CPO’s price reach RM3,000 per ton above, they will imposed windfall profit tax (WPT) 15% for Peninsula and 7.5% for Sabah and Sarawak. However, some subsidies had been dropped into the wrong hands such as restaurant operators, hawkers, and small-scale food-based industries. There is an issue raise in the market that government should revise the amount of subsidy on the price of cooking oil.

            From my view towards this issue, I think government should take an action to revise the amount of subsidy on the cooking oil. This is because the subsidy is often being distributed into the wrong hands but not to the targeted household consumers group. This would be allowed the non-targeted groups to misuse the usage of subsidy. The main purpose of subsidy given by the government to producer is to help them to produce the product with a lower cost and allow the consumer to buy the product they needed at a much cheaper price in the market.

Subsidy is actually the payment made by government to the producer. The subsidy give out by the government can lead to the price of cooking oil in the market to be lower. Besides that, it also increases the production since the cost of production has been reduced with subsidy given. As the cost to produce the cooking oil decrease, the supply curve will be shift to right and the producers are willing to supply or produce more cooking oil to the consumer.

As the times go on, it will appear a situation which is the shortage because the price of the subsidized cooking oil is low now then it causes many consumers include non-targeted and targeted group want to purchase this cooking oil but the quantity of this product is not enough for every consumer especially during the festive season. Therefore, government should revise about the amount of subsidy towards the price of cooking oil. Government can reduce the amount of subsidy given out and only distributed to needy group such as poor people in the urban and rural area.

Cooking oil is a necessity good which is critical for our well-being in daily life. As we know that the closer the substitute of a good, the more elastic is the demand for it. Necessity goods usually have poor substitutes. Hence, cooking oil which is one of the necessity goods has an inelastic demand compared to the luxury good. As the shortage of subsidized cooking oil arises, the demand for the subsidized cooking oil is highly or perfectly inelastic. Consumers are not so easy to change their buying behavior and actually continue buying the subsidized cooking oil because they need the cooking oil to cook their meals every day. They maybe only will swap to buy other brands of cooking oil instead of subsidized cooking oil in the market.

In my opinion, subsidy is good and bring benefits to everyone include consumers and producers. For the producers’ side, the subsidy given sometimes can be the tool to help the firms or industries to expand their market in other countries. As the firms with the subsidy given by the government, they are more able to compete with their competitors in other countries and it actually stimulates the firms or industries’ growth. For consumers’ side, the targeted household consumer group able to buy a much lower price of cooking oil compared with the original market price.

However, when the subsidy given is too much to the producers, it will lead to market failure. Market failure will occurs when the market don’t achieve an efficient outcome or output. Market failure can be due to the problem of overproduction and underproduction. The subsidy given out by government which has decreased the price of cooking oil paid by the consumers and also increased the prices received by the producers. Thus, the producers increase their quantity produced and their marginal cost of producing the additional unit of cooking oil also increases. The marginal social benefit (MSB) equal to the market price which has been fallen as the quantity of cooking oil produced with the subsidy given. Marginal social cost (MSC) has been increased and exceeds the market price. At the same time, the marginal social cost (MSC) exceeds the marginal social benefit (MSB) so the increase in the production will cause inefficiency. At last, the market failure is occur because of the inefficient overproduction.

The explanation is shows as a diagram below that how the production of cooking oil will be inefficient when subsidy is given by the government. 

                The inefficient overproduction not only causes market failure but also the misallocation efficiency’s problem. As the cooking oil produced by the producers is overproduce, the place to allocate the products also inefficient now. Allocative efficiency is achieved when the marginal benefit (MB) equals to marginal cost (MC). However, when the products are overproducing, the marginal cost (MC) exceeds the marginal benefit (MB) so the allocative efficiency also will not be achieved and it will resulted in misallocation of cooking oil.

           Lastly, I would like to conclude overall that the article about the subsidies distributed by the government on cooking oil. As the subsidy imposed on the cooking oil, the price will be lower compared to original price and also encourage producer to produce more products to consumers because the cost of production is low now. However, government should think wisely when they impose the subsidy to the society in order to avoid the amount of subsidy goes to the wrong hands.