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Implications of Fuel Subsidy Cuts in Indonesia

Apr 23, 2023 | 0 comments

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Apr 23, 2023 | Essays | 0 comments

  1. Compare the change in sales of subsidized vis-à-vis non-subsidized fuel between 2011 and 2012.

The subsidized fuel increased in sales in the years 2011 to 2012, from 41.7 million kilolitres to 44.96 million kilolitres. While the non-subsidized fuel decreased in sales from 22.91 million kilolitres to 19.92 million kilolitres.

b. Suppose that the quantity demanded of Premium petrol is 8 million kilolitres for Rp 14,500 per liter. For simplicity, assume that, before the cut in subsidy, Pertamina sold 28 million kilolitres of Premium. On a relevant figure, draw a demand curve for Premium petrol.

(i) Mark the prices and quantities before and after the cut in subsidy

(ii) Calculate the change in the buyer surplus.

Before cut in subsidy= 28 million buyers

After a cut in subsidy= 8 million buyers

Change in buyer surplus= 28-8= 20 million

Therefore, there was a reduction in buyer surplus by 20 million

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  1. Suppose that, before the cut, the government subsidy for Premium was Rp 3,000 per liter. Calculate the effect of the cut in subsidy on government expenditure.

In June 2013, the subsidized premium price rose to Rp 6500 from Rp 4500

Initially subsidized premium price= Rp 4500

New subsidizes premium price= Rp 6500

Cut in subsidy= (New subsidizes premium price- Initial subsidized premium price)

Rp 6500- Rp 4500= Rp 2000

Before the cut, the government subsidy for Premium was Rp 3,000 per liter

Initial subsidy= Rp 3000

Subsidy cut= Rp 2000

New subsidy= (Initial subsidy- Subsidy Cut)

Rp 3000- Rp 2000 = Rp 1000

Fuel subsidy removal will improve the budget of the government. Expenditure wise, the government will be having more rooms for various fiscal policies. The extra budget not used on subsidy will be re-allocated to various programs.

d. From the viewpoint of reducing government expenditure, which is better? Elastic or inelastic demand for petrol?

Elastic demand is whereby a slight price change results in a drastic change in demand for goods and products. On the other hand, inelastic demand is whereby a price change may have little or no effect on the demand of consumers. Petrol demand is quite inelastic because of few alternatives, and therefore price increase in petrol does no reduce its demand significantly. Therefore, from the viewpoint of reducing the expenditure of the government, inelastic demand is better because whether they subsidize it in small amounts or large amounts, there will be no change in demand.

e. How would the cut in subsidy effect:

(i) Taxi drivers

A cut in subsidies of fuel leads to a rise in the price of the fuel. The taxi drivers will have to pay more for the fuel they are using in their cars

(ii) Owners of taxi licenses

Because of the fuel price increase, they will have to receive low income from the taxi drivers they have employed. They can alternatively shift the burden to their customers and increase fare prices, but they risk losing their clients

(iii) Pertamina

Pertamina is the sole supplier of subsidized fuel in Indonesia, hence they enjoy the monopoly. Cut in subsidy may not have a significant effect on their sales because of the market power they enjoy. The consumers will have less choice, they will enjoy the market power and the demand will be inelastic

(iv) Shell

Shell, which is another alternative fuel supplier to Pertamina, may also not see significant changes in their sales. This is because they don’t sell subsidized fuels, to imply that their prices are higher than subsidized fuel being sold by Pertamina. A cut in subsidy also implies that subsidy is still being applied though in fewer amounts but is better than fuels that are not subsidized.

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