Government to review on providing subsidy to Taiwan citizen may give diverse effect

According to the article, `Taiwan government plans LED lamps subsidy’, published on 3 Oct 2012, states that Taiwan government are planning on providing subsidy for LED lamps. Subsidies represent payments to producers by the government which reduce their variable costs of production and encourages them to expand their output. It involves a direct payment by the government to a producer to make the price paid by consumer less than it should be. Subsidies are often used by government to influence production and the prices of commodities in an economy. Government only provide the finance that is needed to produce a good or services. It is important to note that it does not necessarily mean that government has to produce the particular product. Governments may intervene in markets in order to try to restore economic efficiency. If markets are seen to be failing, for the sorts of reasons indicated earlier, then the government may try to move the market to a more efficient position through the use of various policies. Both productive and allocative efficiency could be improved through the introduction of appropriate government policies which in this case, is subsidies. Subsides are usually provided when the government are convinced that the goods and services will bring benefit to the consumer. On other words, subsidies are paid for goods that give positive externalities. The graph below shows how subsidies move the market demand and supply curve:

                     Based on the graph above, subsidies will increase the supply thus, shift the firm’s supply curve to the right. This happened because the cost of production of LED lamps is reduced because of the government subsidies provided. The equilibrium point without government intervention is at the green point where D₁ = S_1. Equilibrium price falls from P₂ to P₁ and quantity supply increase from Q₁ to Q_2. If we apply this theory to the real situation in Taiwan, with no subsidy, the price of the LED lamp is at P₁ with the quantity supplied at Q_1. With a subsidy of NT$200 per LED lamp for five to ten lamps, the price will go down to P₂ along with Q₂ as the quantity supply. If the firm’s demand curve in more inelastic, it will result in a greater consumer’s gain from a subsidy. This is because, an inelastic demand curve does not give much response to the changes in price. On the other hand, when demand is perfectly inelastic, the consumer will gain all the subsidy because the market price will drop by the entire amount of subsidy. Besides that, a perfectly inelastic demand curve is not responsive at all to the changes in price. Indeed when the demand is relatively elastic, the price will affect more on the quantity bought and sold, therefore result on a small fall on the price. By contrast to inelastic and perfectly inelastic demand curve, elastic demand does give a great effect on the changes in price. This can be shown by the graph below :

                        In this case, Taiwan’s government are willing to provide a subsidy of NT$200 per LED lamp which usually cost NT$400-500. This means that the subsidy could have covered mostly half of the original price. This will boost up demand for LED lamp by half of the usual quantity demanded before the imposition of subsidy. Therefore, manufacturing firms who produce their own LED lamp will tend to increase production as soon as the news of an imposition of subsidy was released. Besides that, subsidies can affect consumer surplus. Consumer surplus is the excess of the benefit received from a good over the amount paid for it. The difference between what the consumer actually pays for a commodity and the maximum sum they would have been willing to pay is also referred to as consumer surplus. It is measured by the area below the demand curve, above the price line. As subsidy is introduced, the price of the LED lamp is reduced. For any good and services, though, there are always some people who are prepared to pay above the given price to obtain it. Therefore, as the price of LED lamp reduced, the difference between the amount of the consumer are willing to pay and the real price (after subsidy) is increased. Consequently, consumer surplus is increase. It can be shown by the graph below :

                                                                                                                             

According to the graph, the consumer surplus before subsidy is represented by area A. The area of A,B,C and D appears as the consumer surplus after subsidy was introduced. This proves that consumer surplus increase as subsidies are introduced.

                        There are several effects of the introduction of subsidies to the market which includes inefficient overproduction. The marginal social benefit matched the market price which has decline. On the other hand, marginal social cost has increased and exceeds marginal social benefit. This will result in a surplus. It is a waste to produce a good excessively. It could lead to misallocation of resources as the resources could be used to produce other goods and services which give a higher benefit. In addition, subsidies makes the poor people afford to buy the LED lamps. However, it gives advantages to people who already could afford to buy LED lamp before subsidy. They will enjoy the lower price in the market. Furthermore, subsidies could maintain or increase income (revenues) of producer as well as boost the real living standards of some groups of consumers, for example, lower income households.  As expected, there is considerable debate over which is the best method of government intervention when externalities are present in the market. Whether or not subsidies are a way to get rid of the market failure in economy, it depends on how effective is the amount distributed. Subsidies causes heavy reliance on the government, like Malaysia. Subsidies is probably good for a short term fix in overcoming market failure, but in the long run, not a good idea. Lifting the subsidies will cause social unrest due to their comfort in relying on the government to provide subsidies.Government subsidies inevitably carry an opportunity cost and in the long run there might be better ways of providing financial support to producers and employees in specific industries.

                                                                   
By Siti Nurdiana binti Kamalul Arifin