Economics SL Maanav Khaitan 11 A

Practice Commentary
Article Title: ‘MP govt announces electricity subsidy to benefit farmers’ (Article 8)
Source: Press Trust of India
Date of Publication: June 21, 2017
URL: https://www.indiatoday.in/pti-feed/story/mp-govt-announces-electricity-subsidy-to-benefit-
farmers-947897-2017-06-21

This article discusses the Madhya Pradesh Government’s decision to provide a subsidy of Rs. 8700
crore on electricity, with the agriculture sector availing Rs. 8400 crore. The government shall ‘pay
the amount to power companies’, involving ‘Rs. 1.75 per unit’.

Subsidies refer to assistance by the Government to firms, individuals, or sectors. Specific subsidies
involve payments of fixed amount per unit.

Diagram 1 (below) illustrates the subsidy’s impacts on Madhya Pradesh’s electricity market:

Assume the market started at equilibrium (point A in diagram), at intersection of demand curve D
and supply curve S1, with equilibrium quantity Q* and price P*. After the subsidy, power
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Economics SL Maanav Khaitan 11 A
companies would increase electricity supply, causing rightward shift of supply curve S1 to S2,
equivalent to downward shift by subsidy amount per kWh, due to non-price determinants including
subsidy reducing marginal cost of producers, increasing profits and incentivizing increased supply.
Demand curve D remains constant, but quantity supplied at price P* increases to Q2, creating a
surplus of Q2-Q* at P*, causing downward pressure on price, a signal and incentive for producers
to decrease quantity supplied and consumers to increase quantity demanded. A new equilibrium is
reached (point B), with lower equilibrium price PC (paid by consumers) and greater equilibrium
quantity QS. Price received by producers is PP, equalling PC + subsidy amount per kWh. Total
amount paid by Government equals ((PP-PC)xQS), shaded green.

This is an input subsidy, as electricity is a factor of production for farmers. Along with Government
extending interest-free loans and providing free power to certain farmers, the lower electricity price
PC caused by subsidy decreases production costs of agricultural goods for farmers and increases
profits, incentivizing increased agricultural goods supply, consequently creating surplus and
downward pressure on price, reaching a new equilibrium with increased equilibrium quantity and
decreased price.

The subsidy benefits power companies, as increased price PP and quantity supplied QS increase total
revenue from (P*xQ*) to (PP xQS). It benefits farmers, decreasing electricity cost to PC and
increasing quantity to Qs, reducing production costs and increasing profits. As agricultural goods
are usually necessities with few substitutes, however, their demand is price inelastic, causing their
decreased price after increased supply to influence revenue more than increased quantity demanded,
lowering farmer revenues. Less directly, agricultural workers benefit in long-term since greater
quantity supplied creates employment. Consumers of agricultural goods benefit due to decreased
price and increased quantity supplied. More notably, the Government is harmed in the long-term by
paying the subsidy, a burden on its budget, causing reduced expenditures elsewhere, like on merit
goods, raised taxes, or a budget deficit. However, Government could initially benefit due to greater
political popularity amongst farmers, which appears a priority, evidenced by ‘large-scale farmer
protests’ in the article.

The subsidy increases consumer surplus (area under D above Pc upto QS) and producer surplus (area
above S1 below PP upto QS), outlined in diagram. Nevertheless, the subsidy is paid using taxes -
with an opportunity cost - equalling the gain in social surplus plus the triangle ABF in diagram 1,
making Government expenditure greater than social surplus gains, causing welfare loss (equalling
triangle ABF) for society. The subsidy hence overallocates resources (as QS>Q*) and causes
allocative inefficiency. In the long-term, the electricity subsidy is a perverse subsidy (having
adverse unintended consequences), since electricity is generated using fossil fuels, causing negative
externalities of production, including air and water pollution and health complications. As the
subsidy decreases electricity price for consumers, it could cause overutilization, creating
environmental and social harm.

This commentary has assumed ceterus paribus, but in reality, other factors could affect demand and
supply. It is assumed the electricity market began with allocative efficiency, causing welfare loss
after subsidy, but if positive externalities initially existed, the subsidy could correct them and reduce
welfare losses instead. It is assumed that farmers increase agricultural goods supply when
production costs decrease. Farmers may not reinvest their increased profits into production, or may
not increase supply in short-term, due to long durations for acquiring resources.

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In conclusion, although the subsidy benefits power companies, farmers, the Government, and
workers, this is outweighed by long-term negative impacts on numerous stakeholders. Initially, the
Government may quell protests, but over time, decreased revenues and other damages may not
‘placate farmers’. An alternative solution like a price floor on agricultural goods with Government
purchases of surplus may be more suitable to support farmers, increasing farmer income while
causing fewer negative environmental impacts than the subsidy.

Word Count: 750 words

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