Teh tarik, price controls, and subsidy .....
The other day over teh tarek in a mamak shop, I had an argument with a friend on what subsidy and price controls really were, i.e. price controls on retail items and subsidy of the kind that was on the news just days before the general election on 8th March 2008 when someone in government mentioned that it cost Malaysia some RM 35-40 billions in subsidy to control the prices of commodities, particularly, fuel. The fellow drinker subscribed to the notion that if there had been no price controls, then the government would be seen as not doing its job as the consumers will be the hardest hit. I argued back that why should there be any price controls over everyday items, such as rice, sugar, fuels and so on when the was such a thing as market forces. I further argued that market forces and the law of supply and demand kicked in to ultimately determine the prices of goods, any goods.
While what we argued about was not high-brow economics, my point was that market forces would reach an equlibrium position when a consumer was willing to pay for a commodity or a product at a certain price and a supplier was willing to part with it at that price and vice versa. As and example, I argued that if somehow today the mamak shop decided to increase the price of teh tarik from the present one of RM 1.50 per glass to say RM 5.00 per glass, then the shop would see the last of me and I would be taking the teh tarik in another mamak shop that offered RM 1.50 per glass. If however all the mamak shops in the vicinity conspired to sell their teh tarik at RM 5.00 per glass, then I would stop drinking teh tarik at the shops and make my own at home or stop drinking teh tarik for good.
My reaction to the increase would be similar to the thousands of teh tarik drinkers in the vicinity. The mamak shops would not only have lost his teh tarik business, but would experience a greater loss of business in his roti chanai and nasi kandar. The mamak would have to revert back to their original price of RM 1.50 per glass or at best at RM 1.80 per glass when consumers would accept that the price was reasonable. The government need not have to step in to control the price of teh tarik as the market forces and demand-supply law had taken care of the situation.
In a price control situation of say a commodity such as rice in which people in the supply chain such as farmers, millers, distributors, dealers and retailers are under pressure to increase the price of rice because other factors such as costs of transport, wages, rentals of land , premises and so on, the government steps in ensure that the retail price is fixed at say RM 5.00 per kilo. Why the government steps is because it has to be seen as doing its job for the people, when its agenda is to maintain the price of rice and especially if election is near. In this situation, only those in the supply chain stand to lose or rather to experience a shortfall in profit. The beneficiaries are the consumers, while the government suffers no monetary loss at all.
We all hear about the billions of ringgit of subsidy that the government repeatedly announce in the media to control the price of say petrol at RM 1.92 per litre. If there had been no subsidy, then the pump price of petrol would be not less than say RM 5.00 per litre consistent with the global price of crude oil and with the price in countries where there are no subsidies.
First of all, I assume that the subsidy is a direct subsidy. The government compensates the oil companies the price differential of RM 3.18 for every litre of petrol. Or the government indirectly subsidies the oil companies by way of tax reduction, reduced levies, reduced this and that, whatever. Or the compensation is a combination of both direct and indirect by some formula cooked up by the government and oil companies. In either case, government revenue would still experience a shortfall of RM 3.18 per litre. The government gets some relief in its compensation if it removes restriction ( if there is any) in exports of oil by the refineries to other countries at whatever price the oil companies can sell, in the form of export duty and levy related to the export price.
Whatever is the situation, we are repeatedly told that the amount of subsidy is anywhere between RM 35-45 billion, an amount so huge that it can be used for the country's development, instead of going to the coffers of the oil companies whose profits are already tremendous. It is said that for every USD 1.00 increase in the price of crude per barrel, the oil companies make anywhere between USD 3.00 to USD 5.00 per barrel in net profit !! Just imagine that from the time of crude oil being priced at USD 20 per barrel some 5 years ago to now of USD 100 per barrel, the oil companies make a net profit (bottomline) of between USD 240 to USD 400 per barrel !!
Under construction ....
posted by Richard Sorge @ 2:55 PM
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