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1.0 Article Summary
The newspaper article, “Sugar Importers keeping prices low for consumers” (Bernama 2010), from the Borneo Post is analyzed. The Malaysian government will reduce sugar subsidies and increase sugar prices (Bernama 2010). Furthermore, manufacturers have entered into long-term contracts for imported raw sugar to keep prices low (Bernama 2010). Thus, consumers will pay low prices for sugar even though the government will increase sugar prices (Bernama 2010).
2.0 Introduction
Producers make raw sugar from sugar beets and sugar cane. Although Malaysia does not produce raw sugar, it imports it from Brazil. Then Malaysian companies refine the raw sugar into white sugar. Subsequently, consumers, food companies, and restaurants add sugar to drinks such as coffee, teas, juices, and sodas or blend the sugar into desserts for pies, cakes, candies, puddings, etc.
In this essay, supply and demand are used to analyze which factors cause raw sugar prices to rise. Then the elasticity for white sugar is examined, and whether firms would earn greater profits by increasing white sugar prices. Finally, the economic impact is studied when a government reduces the sugar subsidies.
3.0 Analysis
The analysis is divided into three sections. First, the demand and supply of white sugar is analyzed using derived demand. Second, the focus switches to price elasticity of demand for white sugar, and whether companies can boost their profits by raising white sugar prices. Finally, the social welfare effects of the government reducing the sugar subsidies are studied.
3.1 Demand and Supply
In the article, “global raw sugar prices continually on the uptrend” (Bernama 2010). Unfortunately, the article was ambiguous because Bernama does not identify the factors that are raising raw sugar prices. The market price for raw sugar is increasing, but Bernama does not report the changes in market quantity.
The analysis begins with derived demand where two markets are side by side - a consumer market and a resource market. Manufacturers supply consumers with the product but demand a critical resource to make the product. Hence, the Malaysian sugar manufacturers supply the consumer market and become the consumers in the resource market.
The white sugar market represents the consumer market in Figure 1. The demand function represents the consumers, restaurants, and food companies because they add white sugar to a variety of products. The demand function has a negative slope that reflects the Law of Demand. As the market price increases, consumers, restaurants, and food companies reduce their quantity demanded, ceteris paribus. On the other hand, the supply function reflects the raw sugar manufacturers. They refine raw sugar into white sugar and obey the Law of Supply - as the market price rises, manufacturers boost their quantity supplied, ceteris paribus. The intersection of the demand and supply functions determine the market price, P* and market quantity, Q*.
In Scenario 1, many things could cause a higher demand for raw sugar. For instance, consumers boost their demand for sugar and sugar products because their incomes increase. Then the demand function would increase and shift right in Figure 1 if sugar were a normal good. According to Abler (2010, 20), sugar is a normal and necessity good in Russia, India, and China with an income elasticity of demand ranging between 0.64 and 0.8. Thus, both the white sugar price and quantity rise while sugar manufacturers increase their quantity supplied.
For the sugar manufacturers to raise their quantity supplied, they must process and demand more raw sugar in Figure 2, shifting the demand function rightward for raw sugar. The demand reflects the sugar manufacturers while the supply reflects the sugar mills in Brazil that make the raw sugar. This market also obeys the Law of Supply and the Law of Demand. Consequently, both market price and quantity rise.
Figure 2. Malaysian manufacturers demand more raw sugar
For Scenario 2, many factors could cause the supply function to decrease for raw sugar. For example, Brazil could have experienced a severe drought that wiped out its sugar cane. Subsequently, the supply of raw sugar decreases in Figure 3. The market price rises while market quantity falls.
Figure 3. A drought reduces the supply of raw sugar
Malaysia sugar manufacturers pay higher prices for raw sugar and reduce their purchases because they pay greater prices for a resource input. Malaysian sugar manufacturers would reduce their supply of white sugar in Figure 4. Thus, the market price rises while market quantity falls for white sugar. Then consumers, restaurants, and food companies pay greater prices for white sugar and reduce their quantity demanded.
Figure 4. Malaysian manufacturers reduce their sugar supply because a price of a resource has risen
3.2 Elasticity and Changes in Total Revenue
Article does not provide enough information to calculate the Malaysians' price elasticity of demand for sugar. From the Commodities and Trade Division (2002), the price elasticity of demand for Americans, Japanese, and Europeans are -0.11, -0.81, and -0.12 respectively. Consequently, sugar is an inelastic product.
Elasticity depends on the number of substitutes and income effects. Sugar has few substitutes except artificial sugar. Some consumers refuse to use artificial sugars, such as aspartame, sucralose, and so on. because they may induce health problems in consumers. Moreover, sugar comprises a small fraction of consumers' income, so they may not be sensitive to price changes.
If sugar manufacturers raise the price for white sugar, then they will collect more revenue (Hubbard et al. 2010, 105). However, changes in profits are ambiguous because the article was not clear how the firm's revenues and costs change (Bernama 2010). First, government will reduce the subsidy, which lowers the firms' revenue. Second, the government raised fossil fuel prices. Thus, manufacturers use energy in production, and they will pay higher energy costs. Third, article stated manufacturers "have to account for capital expenditures" (Bernama 2010). This means the companies are upgrading machinery. Then Bernama added increased labor costs, which are not capital expenditures. Labor costs are included into production costs. Finally, manufacturers entered into contracts to lock in low prices for raw sugar (Bernama 2010). However, if raw sugar prices remain high, Malaysian firms will pay greater raw sugar prices when issuers of contracts for raw sugar rise in the future. This only provides a temporary solution.
3.3 Sugar Subsidies
Malaysian government subsidizes sugar prices (Bernama 2010). It does not impose price ceilings or price floors because a price ceiling could lead to shortages while a price floor could create a surplus. The economics of a subsidy is analyzed.
The Malaysian sugar manufacturers supply the sugar while consumers, restaurants, and food companies demand sugar. The intersection between the supply and demand functions determines the market price and quantity with no government subsidy in Figure 5.
Figure 5. Government pays a subsidy to the sugar manufacturers
The Malaysian government pays a subsidy so Malaysians will pay PS for sugar price. A subsidy is the opposite of a tax and shifts the supply curve rightward (Szulczyk 2012, 57-8). At PS, consumers want to purchase QS units of sugar. For manufacturers to supply that level, they must receive the PS + Subsidy (Szulczyk 2012, 57-8). Consequently, the subsidy creates a price wedge between the consumers and producers. Consumers pay PS while producers receive PS + subsidies (Szulczyk 2012, 57-8).
For social welfare, government must pay producers the total shaded areas in Figure 5 (Szulczyk 2012, 57-8). Thus, consumers receive the medium shaded trapezoid as a benefit of the subsidy while producers receive all the shaded areas (Szulczyk 2012, 57-8). Since the government had interfered with the economy, the black triangle represents the deadweight loss to society (Szulczyk 2012, 57-8).
Malaysia is unique because the government locks the sugar price at PS. Supply and demand functions continually shift that changes the market prices. However, government will adjust the subsidy so the subsidized price always equals PS.
According to the newspaper article, Malaysian government will lower the subsidies to sugar manufacturers as shown in Figure 6. The original lines for the original subsidy were left in the graph for comparison. Consequently, consumers pay a greater price at PN and consume a smaller quantity at QN. They would lose some consumer surplus because the medium shaded trapezoid becomes smaller. Although the small subsidy reduces the deadweight loss, the black triangle, consumers may not be happy about the higher sugar prices. Moreover, sugar manufacturers receive a small subsidy from the Malaysian government. In addition, the producers collect less of all shaded areas as a subsidy.
Figure 6. Government reduces the subsidy to the sugar manufacturers
4.0 Conclusion
The article was confusing because the author did not explain which factors were raising the raw sugar prices. A higher demand or smaller supply would always raise market prices, and many factors can boost the raw sugar demand or reduce the raw sugar supply.
The Malaysian government benefits because it reduces its subsidy payments to sugar manufacturers. Although the deadweight loss shrinks for a smaller subsidy, consumers lose surplus and may not be happy paying higher sugar prices. Thus, the consumers do not benefit from the higher sugar prices.
The analysis was not clear whether the manufacturers would benefit from the sugar price hikes. They benefit because they receive greater prices for white sugar and they reduced their raw sugar cost by using contracts to lock into low prices. However, the sugar manufacturers receive a lower government subsidy and pay greater costs for capital, labor, and operating costs.
5.0 References
- Abler, David. 2010. "Demand Growth in Developing Countries." OECD Food, Agriculture and Fisheries Papers, No. 29. OECD Publishing. Accessed April 22, 2014. http://dx.doi.org/10.1787/5km91p2xcsd4-en
- Bernama. 2010. "Sugar importers keeping prices low for consumers." Borneo Post Online, August 9. Accessed April 16, 2014. http://www.theborneopost.com/2010/08/09/sugar-importers-keeping-prices-low-for-consumers/
- Commodities and Trade Division. 2002. "4. Sugar and beverages." In Agricultural Commodities: Profiles and Relevant WTO Negotiating Issues. Rome: Food and Agriculture Organization of the United Nations. Accessed April 22, 2014. http://www.fao.org/docrep/006/y4343e/y4343e05.htm
- Hubbard, Glen, Anne M. Garnett, Philip Lewis, and Anthony Patrick O'Brien. 2010. Essential of Economics. Frenchs Forest: Pearson Australia.
- Szulczyk, Kenneth. 2012. The Economics of Government. San Francisco: Scribd. Accessed April 22, 2014. http://www.ken-szulczyk.com/economics_of_government.php
