How does subsidy in oil lead to petrol inflation?

economy How does subsidy in oil lead to petrol inflation?

Answer by Jai Parimi:

Subsidy:

  • A form of financial or in kind support extended to an economic sector (or institution, business, or individual) generally with the aim of promoting economic and social policy.

But, you should understand the types of price change to understand their impact in long term.

  1. Natural Price Change: Prices rise without the intervention of any external factors like money influx, interest rate change,….
  2. Forced Price Change: Prices rise with the intervention of one or more external factors like money influx, interest rate change,….

Now that you understood the 'types of price change' & 'subsidy', I guess it is not difficult for you to understand that "oil subsidy causes an forced price reduction of oil".

What are the impacts of forced price reduction?

  • In short term, Prices decrease which means prices of goods also reduce because of fall in transportation, energy and other costs which causes reduction of inflation rate temporarily. Particularly with oil which takes a huge share in our government's bill, the impact is higher.
  • In long term, Who bears the subsidy? It has to be the government which means the common man like you and me. So, to compensate the costs incurred due to subsidy, they have to increase the taxes (both direct & indirect).
  • Where will this rise in taxes hurt? obviously, the prices of end products. So, What happens to the economy? Prices rise, leading to inflation.

What could be the way to tackle the issue?

  • Limit the subsidies to the really needy.
  • Concentrate on alternative resources.
  • Increase productivity and competitiveness.
  • Robin hood tax structure (beat the rich, feed the poor) works to an extent in the economy. But, too much width in slabs leads to tax evasion by the rich.

Thanks Niharika Banerjee for the A2A.

How does subsidy in oil lead to petrol inflation?

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