Subsidy - Full market impact

What are subsidies?

• Two main reasons for subsidies:

  1. Solve market failure.

  2. Increase affordability of goods/services.

How do subsidies solve market failure?

• Encourages consumption/production of beneficial goods/services.

• Examples: Vaccinations, healthcare, education.

How do subsidies increase affordability?

• Reduces the price of necessity goods/services.

• Helps low-income households access the market.

What is the impact of subsidies on the supply curve?

• reduces the cost of production (COP) for firms.

• Shifts the supply curve to the right (S1 to S1+sub).

• The vertical distance between the two supply curves equals the subsidy per unit.

What happens to price and quantity due to a subsidy?

• Price (P) decreases: P1 to P2.

• Quantity (Q) increases: Q1 to Q2

What is the government cost of a subsidy?

• The area of the rectangle: P2, b, c, d.

• Calculated as: Subsidy per unit (b to c) x Quantity (up to Q2).

How does producer revenue change with a subsidy?

• Increases from: P1, a, Q1, 0 to d, c, Q2, 0.

• Subsidy goes to producers, so government cost equals producer revenue.

What is consumer savings with a subsidy?

• Area: P1, P2, a, e.

• Consumers pay a lower price (P1 to P2).

• Consumer surplus increases.

What is deadweight loss (DWL) from a subsidy?

DWL is the area: A, B, C.

How is the government cost of a subsidy calculated?

• Vertical distance between supply curves (b to c) is the subsidy per unit.

• Multiply subsidy per unit by all units produced (up to Q2).

• Total area: P1, b, c, d.

Why do consumers like subsidies?

• Prices fall.

• Consumer surplus increases.

• Greater access to goods/services.

What are the long-term costs of subsidies for consumers?

• Funded through:

  1. Taxes (hurts consumers).

  2. Cuts in other government spending.

  3. Government borrowing (creates debt).

Why do producers like subsidies?

• Revenue increases significantly.

• Producer surplus rises.

• Greater employment as quantity increases.

Why do governments like subsidies?

Achieves goals:

1. Solves market failures.

2. Increases affordability.

What concerns do governments have about subsidies?

• Expensive to fund.

• Risk of producers misusing subsidies.

• Long-term dependency by producers.

• May lead to rising costs of production (COP) over time.