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Scarcity and the influence of subsidies

It would be a natural response of consumers in a free market to respond to increasing prices by changing their behavior to consume less of the resource or product.  If the price of gasoline reaches $3.50/gallon, people will tend to drive less than if gasoline were $1.00/gallon. If the price of electricity increased 500% overnight, people would take a much harder look at LED lighting, improvements to the energy efficiency of their homes, or perhaps invest in down jackets. Regardless of the mitigating behavior, in time, the market would find equilibrium between supply, demand, and price. But, that market balance can be upset in a significant way by subsidies. If there is an "invisible hand" which finds balance and equilibrium of market forces, we can think of subsidies as an "invisible finger" pushing down on one side of the scale. In essence, subsidies distort the balance of markets. If a government subsidizes the price of gasoline, it weakens the price signals which balance supply, demand, and price. This can lead to severe overconsumption of resources.

For decades, governments from Egypt to Indonesia have subsidised the price of basic fuels. Such programmes often start with noble intentions—to keep down the cost of living for the poor or, in the case of oil-producing countries, to provide a visible example of the benefits of carbon wealth—but they have disastrous consequences, wrecking budgets, distorting economies, harming the environment and, on balance, hurting rather than helping the poor.

Emerging markets are not the only places that distort energy markets. America, for instance, suppresses prices by restricting exports. But subsidies are more significant in poorer countries. Of the $500 billion a year the IMF reckons they cost—the equivalent of four times all official foreign aid—half is spent by governments in the Middle East and north Africa, where, on average, it is worth about 20% of government revenues. The proceeds flow overwhelmingly to the car-driving urban elite. In the typical emerging economy the richest fifth of households hoover up 40% of the benefits of fuel subsidies; the poorest fifth get only 7%. But the poorest suffer disproportionately from the distortions that such intervention creates. Egypt spends seven times more on fuel subsidies than on health. Cheap fuel encourages the development of heavy industry rather than the job-rich light manufacturing that offers far more people a route out of poverty.

The Economist (2014, Jun 14). Scrap them. Retrieved Feb 3, 2014.

Below is a Congressional Budget Office view of United States energy subsidies over the past decades.  Consider the influence these subsidies may have had in increasing–or decreasing–innovation and natural market balance. In the next lesson, we will explore the relationships between subsidies, greenhouse gas emissions, and carbon taxes.

Hydropower

Here is a pie chart test. Drawbacks include only whole numbers and display is inside chart.