Petrol Subsidies in Nigeria

Topics: Supply and demand, Subsidy, Mixed economy Pages: 5 (1557 words) Published: September 8, 2013
ECON1101 Essay: Petrol subsidies in Nigeria

Nigeria, an oil-abundant nation, produces two million of barrels of crude oil a day, though despite this, it relies solely on importation to sustain its refined-fuel needs. This is because its four refineries fail to function effectively and continue to operate beneath capacity. Governmental mismanagement and political corruption are some of the reasons why Nigeria’s refineries remain in this state. The Nigerian government therefore implemented subsidies in order to minimise and control prices for its imported petrol. These subsidies are government payments to firms, such as the Nigerian National Petroleum Corporation who imports and distributes petrol, in order to keep the price of petrol low so that a lower cost of living may be attained.

The market for petrol in Nigeria is currently inefficient due to the utilization of this price control scheme. Figure 1 highlights the effect of the imposed subsidy on the market. This figure highlights the shift in the supply curve to the right, from S to S+Subsidy, due to the imposed subsidy. The reason for this shift is that the government subsidy would lower production or transportation costs for firms and allow more petrol to be imported, thus increasing the supply of petrol from producing firms and lowering the price from P0 to PS. The inefficiency of the market is indicated by the deadweight loss at Point C, due to the fact that the government has to cover the additional costs to the right of the demand curve that is developed by the subsidy. From the diagram, consumer expenditure remains relatively low in comparison to the total revenue producers generate, indicating that the government expenditure in is quite high, around $7 billion a year, as indicated by Article 1. Therefore, Nigeria’s president Goodluck Jonathan wished to deregulate these subsidies in order to utilise the state’s funding to better develop the country’s infrastructure.

Figure 1: Demand & Supply Curve indicating the effect of a subsidy on the petrol market

The subsequent deregulation of Nigeria’s petrol subsidies resulted in the return of the market to equilibrium. This is indicated diagrammatically by the removal of the S+Subsidy curve in Figure 1, resulting in the market equilibrium for petrol shown by Figure 2. As a result of this shift back to equilibrium, the price of petrol increased from Ps to P0. Due to this, the price of petrol more than doubled, from about $0.40 to $0.93 a litre causing thousands of people to on strike and protesting for the restoration of the subsidy. This caused a standstill for Nigeria as shops, businesses and markets were closed for days and oil production was under threat of termination, due to heavy retaliation by the Nigerian people in regard to the removal of the subsidy.

Figure 2: Demand & Supply curve after the removal of the subsidy on petrol

Consumer expenditure on petrol would have increased, as petrol, being an essential good, is highly price inelastic, and therefore an increase in price would only incur a small change in quantity demanded. Total revenue for producers would have decreased, as producers would no longer receive subsidy payments from the government, causing quantity supplied to reduce. Therefore, the removal of the subsidy would increase total consumer expenditure and decrease total producer revenue, to equate to the red shaded area indicated by Figure 2. Food prices increased as a result due to the increasing cost of production and transportation. The rising transportation costs increase the prices of inputs, and the increasing production costs means producing the same good becomes more expensive. Producers of food products are therefore forced to pass on costs to the consumers by increasing prices in order to ensure their survival.

The key economic arguments for removing the subsidy on petrol would be the return to an efficient market for petrol, as the imposed subsidy would no...
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