Wednesday, September 18, 2013

In Egypt bread is cheap but there is none to buy. See here how subsidies without resources created this situation that has the potential for creating civil unrest.

What Egypt Wants: Cheaper Bread  Demand for Subsidized Food Vexed Ousted President and Pressures Interim Government

"...Egypt's Islamist government, during its brief reign, couldn't satisfy public demand for subsidized food and fuel—spurring discontent that helped the military drive it from power. 
The military-backed leadership that took over this summer is now wrestling with the same challenge, trying to make sure there is enough cheap bread for the country's poor..."
The purpose of a subsidy is to lower the price of a good so people can buy more of it AND to give producers an incentive to produce more.  The implication is the market place is under-producing the good and charging too high a price for the intended consumer.  However, to make it work, the resources needed to produce the extra units of the good need to be available for conversion.

In Egypt the subsidy along with the lack of available resources, in this case wheat, are wreaking havoc on the domestic economy.

Let's look at it in graphs!

Here is the Market for Bread in Egypt at some equilibrium "A" with a Price of $1.00.  Any number you see I made up for simplicity.  Insert the equivalent in Egyptian currency and it still works the same way.  
If a subsidy is offered to consumers to buy bread at a lower price than the current market price, then consumers will want to buy more bread.  The Demand for Bread will increase and the Demand Curve will shift to the Right:
Notice that the Price increased to $1.50 (Point "B"). Producers responded to the increase in demand by increasing the QUANTITY SUPPLIED (movement ALONG "S*), assuming the availability of wheat, because of  the change in price driven by the demand side.

But hold on! Remember Demand only increased because of the presence of a subsidy.  Assume that subsidy is $1.00.  So, we have to subtract $1.00 from our market price (Point "B" to Point "C"):
The Price of Bread to the consumer is now $.50, $.50 LESS than before the subsidy (HAPPY CONSUMER!). The producer receives $1.50, $.50 MORE than before the subsidy (Happy Producer!).  While the TOTAL subsidy is $1.00, because of relative elasticities (another lesson) the subsidy is split between the consumer and the producer.

The end result is the consumer gets bread for less than what they know is the true market price, thanks to the government.

However...All is not well with this arrangement. Remember I said this hinged on resources being available to increase the market quantity supplied? This is the problem in Egypt:
Since the military-backed interim government took over, it has focused on maintaining supplies of wheat. Egypt's own farms can't meet demand; governments have imported wheat for years, and the country remains the world's No. 1 importer, according to the U.S. Department of Agriculture. 
Egypt's government says it has enough wheat to last until the end of the year. Yet each month, frustrated families who rely on subsidized goods say the state-owned shops that provide basic items for cheap prices often run out of food.
So, local producers do not have the resource/input, wheat, most needed for making bread. This messes up the "increase in Quantity Supplied in response to a higher  price" formula.

Instead of moving up and to the right on "S*" producers are moving down and to the left!  See point "D" in this graph:
At Point "D" at $.50 the Quantity Supplied is "Q supplied" BUT at $.50 the Quantity Demanded is "Qdemanded".  We have a shortage of bread.
Over the past four months, when Mrs. Ibrahim's state-run bakery runs out of bread—which happens often, she said—her only choices are to buy bread at a private bakery where each loaf costs three times as much, at 0.75 piasters (11 cents), or not to buy at all.
 Private bakeries are adequately stocked—but increasingly unaffordable. 
That last sentence is an interesting one. How do private bakeries have bread (unsubsidized and more expensive) and the State owned bakeries have none (subsidized and less expensive)?

Extra credit for giving the right answer.

I hope this helped you understand, using a real life example, how subsidies without adequate resources can distort the marketplace in very harmful ways.

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