The article deals with implementation and removal of a specific subsidy. A specific subsidy is the specific amount paid by the government to a firm per unit output.
Graph 1 shows the removal of the specific subsidy for diesel. The demand of diesel is relatively inelastic. Price elasticity of demand is a measure of how much the quantity demanded of a product changes when its price changes. As we can see, the market is in equilibrium with Q1 being supplied and demanded at a price of P1 (₹47.15/litre). On removal of subsidy XY (₹9.60/litre), the supply curve shifts vertically upwards from S1 – subsidy to S1. The producers will increase their price and lower output until the market equilibrium is regained, which is at a price of Pe, where Qe is both demanded and supplied. The price of diesel rises by XW. The income of producers will decrease from DVQ10 to PeXQe0. The government succeeds in saving DYZP1.
Graph 2 shows the effect of applying a subsidy for LPG cylinders. The equilibrium price (Pe) is ₹895.50, while the consumer is supplied up to nine 14.2 kg cylinders at a subsidized price (P1) of ₹410.50. As we can see, the supply curve shifts vertically downwards from S1 to S1 – subsidy. A new equilibrium is reached at price P1, where Q1 is both demanded and supplied. The price of each cylinder falls by XW (₹485), which is less than the subsidy XY (₹490.50). The income of producers will increase from PeXQe0 to DVQ10. The government expenditure is DYZP1, which is estimated to be INR 93 billion.
Which stakeholders can be identified as the winners and/or losers and what will be the short run and long run implications of the government’s intervention?
Firstly, in the case of the removal of the subsidy on diesel, the winner is the Government of India. It will be able to save the money spent on fuel subsidies. This will improve its fiscal deficit. State-owned oil marketing companies will...