Practice Commentary

This article states that the Government of India has granted a subsidy for the electric vehicle
including three wheelers, two wheelers and 4 wheelers. The subsidy will be based on the size of
the battery and the subsidy will be capped a 20% of the cost of the EV. The panel recommended
5500 crores to be allocated for the subsidy scheme.

The reason for directly subsidizing electric vehicles is to give incentives to consumers to switch
to environmentally sustainable vehicles from the diesel and petrol run vehicles and also
incentivizes producers to engage in the development of electric vehicles rather that fossil fuel
vehicles. This was done to reduce the negative production and consumption externality cause by
fossil fuels.

There are external benefits associated with electric cars in consumption and production
processes. Electric processes cars are sustainable and environmentally friendly, so they do not
create pollution which is caused by the fossil fuels. Their consumption will benefit society as
consumers using electric cars will not be less likely to face problems like asthma. This will result
in healthier workforce and greater productivity. Therefore, the spill over benefit to society is
greater that the cost of producing electric vehicles.

This effect can be seen in the diagram above where the market determined output is Qm; it is
determined by the interaction of Marginal Private Benefit and Marginal Private Cost. Due to the
positive consumption externality, the MSB lies above the MPB and the optimal quantity of the
electric car is given by the interaction of the MSB and the MPC. Since the MSB>MPB resulting in
Qm<Qopt signifying the underproduction of electric cars from the society’s point of view this is an
ideal condition to be identified as market failure. The government intervened by providing a
direct subsidy for electric vehicle. This will shift MPC downwards and intersect MPB at new
equilibrium at Qm1 that is closer to Qopt. It will move closer but not reach the Qopt because there
is a cap on the number of vehicles that will be awarded the subsidy.
Electric vehicles, especially small ones and two wheelers are price elastic (PED>1) since they have
many close substitutes which often tend to be cheaper (petrol cars). So, a decrease in price of 1.4
lakhs would encourage a lot of people to switch to electric vehicles. Since NITI AAYOG
recommended the scheme would have a special focus on metropolitan cities which face a lot of
problems due air pollution by the burning of fossil fuels, such a scheme would play a major role
in decreasing the air pollution by automobiles. Subsidies would also encourage automobile
companies to develop better electric vehicles rather than them enjoying lower taxes on small mild
hybrid vehicle.

However, the subsidy would be given from the government’s revenue and Rs.5500 crore would
have a large opportunity cost that will be paid by the taxpayer’s money. In the short run,
consumers less likely to switch to an electric vehicle because: vehicle-owners would only switch
if they really need a new vehicle and vehicle-owners only purchase new vehicles after the already
owned car is fully utilized. Electric vehicles are considered relatively new technology in India
which is although eco-friendly but less efficient. Furthermore, the unavailability of charging
stations might be seen as a disadvantage by consumers and therefore, people might choose not
to switch to electric cars in India in the short run. Along with subsidies for electric vehicles,
advertising about their positive externalities and taxing of fossil fuel vehicles would be a great
incentive for consumers to consider switching to electric vehicles in the short run. In the long run,
with development in the charging infrastructure and advertising, consumers would be most likely
to switch to electric cars.