[824] Of sugar: price ceiling and oligopoly

Today, in the New Straits Times:

KUALA LUMPUR: The Domestic Trade and Consumer Affairs Ministry plans to cut the number of sugar wholesalers to improve distribution of sugar.

“There are now 2,845 sugar wholesalers and we want to reduce the number to have better control of the distribution. We want to ensure that there is adequate sugar supply,” said Domestic Trade and Consumer Affairs Minister Datuk Mohd Shafie Apdal yesterday.

I want to stress that the current Malaysian sugar shortage crisis is caused by price differentials of sugar within the region; Malaysia has lower sugar prices compared to its neighbors. This in turn causes distributive inefficiency within the country as sugar flows out of Malaysia. Hence, hoarding and smuggling are merely symptoms of that prices differential, not the root cause. Overconsumption is also not the cause — that’s just some dishonest political maneuvering.

Granted, by reducing the number of wholesalers, it will be easier for the Ministry to control sugar distribution. In a way, the government is trying to limit the effects of externality. But notice, the government is using more taxmoney to repair an already inefficient system. A reversion to a competitive market on the other hand will cost the government much less and close to nothing (discounting cost would be incurred by general unrest instigated by opportunists and protectionists).

However, by reducing the number of competitors in the market, the government unnecessarily increase the wholesalers’ market power — at least, power of the ones that will stay in the market. As a result, the market will move closer towards monopoly scenario and farther away from the ideals competitive market. A firm with sufficient market power will have the ability to increase price higher than competitive price. In fact, holding everything else constant, prices will increase while production will decrease from competitive equilibria respectively as firms try to maximize profits.

Since the government is able to control one more variable, there are two issues right now — first is price control which causes distributive inefficiency. Second is number of competitors (as explained, a reduction of competitors will pull the market toward monopoly scenario).

I’m not sure what the net effect is because it will depend on how well the government execute their monitoring and enforcement process to curb externalities. But there will be two extreme scenarios to consider.

One is when the quantity of sugar produced under monopoly without price ceiling (or rather, oligopoly) scenario will be less than quantity produced in a market with only price ceiling. This, in no uncertain terms will worsen the problem.

Two is when the quantity produced in the former state is greater than in the latter state. This will be no different than our status quo.

I’m too lazy to draw proper graphs to explain the whole thing graphically but I did draw them on a whiteboard and I did digitize them. This is one of them.

You’d probably need a little bit of economics to comprehend the badly drawn graphs. But the bottom line is, the final result will depend on which part has a great effect on the system. If the effect of price ceiling has a greater impact compared to price setting power, then the status quo would probably remain, ceteris paribus. If price setting power has greater impact vis-a-vis price ceiling, then we would probably experience a more severe sugar shortage.

Of course, I’m assuming that these wholesalers are competing against each other. By that, I mean, they aren’t owned by an entity, i.e. the government. If they are owned by the government, then this whole entry would be irrelevant.