2. Subsidy

What is a subsidy?

A sum of money granted by the government to a business to encourage the production of merit goods. Firms can then reduce prices, increasing demand.

Draw a subsidy diagram.

State 3 benefits of subsidies.

1. Reduces prices for consumers/

2. Leads to increase in production/ consumption of merit goods.

3. Incentivises firms to take part in beneficial activities. e.g. developing products with positive externalities.

State 4 drawbacks of subsidies.

1. Funded by taxation.

2. Opportunity cost.

3. Govt may have poor info: how much to subsidise? estimate extent of positive externality?

4. Firms may be inefficient and rely on subsidy instead of innovating.