1.2.9b - subsidies

what is a subsidy

a grant from the government to producers to encourage the consumption of goods with positive externalities

effect of a subsidy

will reduce costs of production

supply will shift right

price will be lower

consumption will increase

subsidies graph

lower price is the new price

effects on subsidy on consumer

better off

higher consumer surplus

effects on subsidy on producer

better off

higher revenue

effects of subsidy on government

worse off (spent money)

strengths and weaknesses of subsidy

STRENGTHS:

-easy to understand
-uses price mechanism

WEAKNESSES:

-expensive for government bc the producer takes some of the subsidy
-producers may become dependent
-opportunity cost for government
-inelastic demand = have to have very large subsidy to actually increase consumption

in terms of elasticity, when will the largest fall in price occur due to a subsidy

supply highly elastic

demand highly inelastic

(doesn’t make sense in life but does on the diagram)

in terms of elasticity, when will the smallest fall in price occur due to a subsidy

supply highly inelastic

demand highly elastic

(also may not make sense)

what can you do with subsidies to show how it combats market failure

draw a subsidy on a positive externalities diagram