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Subsidies

Effects of Subsidies on Consumer and Producer Surplus

Diagram Explanation:

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  • Initially, the market is at equilibrium where demand (MB) and supply (MS) intersect, with equilibrium price and quantity P* and Q* -> after a subsidy of ____ imposed to ____ -> producer's cost of production decreases -> producers are more willing to supply -> more quantity supplied -> Q* expands to Qsb -> S1 shifts rightward to S2 creating new equilibrium where MB and S2 intersects

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  • New equilibrium at a lower price for consumer (Pc) and producers receives at a higher price (Pp) because more quantity sold and producers receives subsidy-> therefore, benefits of subsidy is shared among consumers and producers

    • consumers pay P*-Pc less per unit​

    • producers receives Pp-P* more per unit

  • However, gov lose Qsb × (Pp-Pc)

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  • As a result, allocative inefficiency in the mkt & creating DWL of area a

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Evaluation for diff stakeholders:

1) Consumers:

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  • Subsidy lowers price -> good become affordable -> higher purchasing power -> better living standards -> better off 

    • If good has positive externalities (EV) -> cleaner environment -> raise living standards -> better off

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2) Producers:
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  • Subsidy allows producers receive higher higher effective prices -> earn more revenue & profit -> better off

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  • Overdependent on subsidy -> reduced efficiency and innovation because they know they will earn profits -> in the LR competitiveness may fall if subsidy removed -> worse off

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3) Government:

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  • Achieves policy objectives to support key sectors -> subsidy brings benefits in SR to consumers and producers -> gains political supports -> better off

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  • Gov must spend tax revenue to fund subsidy -> opportunity costs -> less spending on healthcare/education/public wages

    • LR -> if gov keep on subsidize firms -> budget deficit may worsen

    • LR -> if subsidies support declining or inefficient sectors -> workers remain in low productivity jobs
      -> limiting  economic growth
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4) Workers:

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  • Quantity demand expands -> more outputs need to be produced -> firms demand more labor -> more opportunities to be employed -> better off

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  • If subsidy later removed: firms may layoff workers to maintain low cost of production -> ensure revenue made -> worse off 

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