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Subsidies

Unit 4 - Lesson 5
Learning Outcomes:
● Define all terms in orange bold in section 4.4. (AO1)
● Explain the consequences of subsidies on markets and stakeholders. (AO2)
● Draw diagrams to illustrate the effects of subsidies on markets and
stakeholders. (AO4)
● Evaluate the effects of subsidies on markets and stakeholders. (AO3)
Introduction to Subsidies
Subsidy:

● Assistance granted by the government to individuals and groups of


individuals. These include:
○ Individuals, firms, consumers, industries or sections of the economy.
● Government granted subsidies include:
○ Direct cash payments
○ Low interest or interest free loans
■ To students
■ To low income individuals to purchase goods and services such as
housing.
■ To firms
Subsidies and the Allocation of Resources
● Subsidies will impact the allocation of resources because they impact
prices.
● The change in prices impact the signalling and incentive function in the
market.
● A subsidy is a non-price determinant of supply - increasing supply
● Increase in supply results in:
○ Decreased price paid by the consumer causing them to purchase
more (Law of Demand).
○ Increased price received by the producer causing them to produce
more (Law of Supply).
● The allocation of resources changes resulting in increased production and
consumption in the free market.
Why Governments Grant Subsidies
● Used to increase the revenues of producer/firms leading to increased
incomes.
● Subsidies can be used to make certain necessities affordable for low
income individuals.
● Subsidies can be used to incentivize the production and consumption of a
good that is considered socially desirable.
● Subsidies can be used to support the growth of certain industries in the
economy.
● Subsidies can be used to encourage the export of certain goods.
● Subsidies are used to achieve a better allocation of resources thus reducing
inefficiencies by correcting positive externalities.
Draw diagrams to illustrate the effects of subsidies on markets and
stakeholders. (AO4)
● A subsidy is a non-price determinant of
supply. Decreases the firm’s cost of
production thus increasing supply (S to
S + subsidy)

No subsidy Subsidy

Quantity Qe Q1

Equilibrium Pe Pc (Price the


Price consumer pays)

Price Producer Pe Pp (Receives Pc +


subsidy)

Amount of 0 (Pp - Pc) X Q1


Subsidy
Explain the consequences of subsidies on markets and stakeholders.(AO2)

Impact to Consumers

No Subsidy Subsidy Incr/Decr

Price Pe Pc Decrease

Quantity Qe Q1 Increase

Consumer A+B A+B+D+ Increase


surplus E+F

Consumer Pe X Qe Pc X Q1 Decrease
Expenditure

Consumer N/A D+E+F Increase


Surplus
Gain
Explain the consequences of subsidies on markets and stakeholders.(AO2)

Impact on Consumers:

● Decrease in price from Pe to Pc


● Increase in quantity purchased from
Qe - Q1
● Increase in Consumer Surplus (A + B)
to (A + B + D + E + F)
● Consumer Gain (CG), the consumer
surplus gained from the subsidy.
○ Located above the price the
consumer pays (Pc) and below the
Demand curve.

Consumers are better off after the subsidy.


Explain the consequences of subsidies on markets and stakeholders.(AO2)

Impact on the Producers


No Subsidy Inc./Decr
Subsidy

Price Pe Pp (Pc + amount of Increase


subsidy Pp - Pc)

Quantity Qe Q1 Increase

Producer D+H B+C+D+H Increase


Surplus

Producer Pe X Qe Pp X Q1 Increase
Revenue

Producer N/A B+C Increase


Surplus
Gain
Explain the consequences of subsidies on markets and stakeholders.(AO2)

Impact on Producers:

● Increase in price from Pe to Pp


○ Receive the (Pc + amount of
subsidy)
■ Amount of subsidy is the
vertical distance between S
and S + subsidy
■ Or Pp - Pc
● Increase in quantity purchased from
Qe - Q1
● Increase in Producer Surplus (D + H)
to (B + C + D + H)
Explain the consequences of subsidies on markets and stakeholders.(AO2)

Impact on Producers

● Producer Gain (PG), producer surplus


gained from the subsidy.
○ Located below the price the
producer receives (Pp) and above
the supply curve.
● Producer Revenue increases from
(Pe X Qe) to (Pp X Q1)

Producers are better off after the subsidy.


Explain the consequences of subsidies on markets and stakeholders.(AO2)

Impact on the Government

Negatively impacts the Government


● Government pays the subsidy which is
a burden to their budget.
● To get revenue to fund the subsidy the
government may need to reduce
expenditures elsewhere in the
economy.
● Government expenditure come at an
opportunity cost to other projects.
No Sub Subsidy Inc/Decr

Government 0 (Pp - Pc) X Q1 Increases


Expenditure
Explain the consequences of subsidies on markets and stakeholders.(AO2)

Impact on Workers

● Since the output has increased the


amount of workers needed to
produce that output will also increase.
● Workers in the industry that is
receiving the subsidized assistance
from the government will be better off.
● The increase in output may have a
negative impact on other industries
thus possibly negatively impacting
jobs in another sector that the
government may have reduced their
expenditure in.
Explain the consequences of subsidies on markets and stakeholders.(AO2)

Impact on Society as a Whole

● Society is worse off after the subsidy


because there is an overallocation of
resources to the production of the good.
● Quantity (Qe) < (Q1)
● Therefore there exists a total welfare loss
of triangle (G).
● The subsidy protects inefficient producers
who have a higher marginal cost (MC)
allowing them to continue to produce.
● The expenditure of the government
subsidy comes at an opportunity cost to
other sectors of the economy thus
negatively impacting society.
Explain the consequences of subsidies on markets and stakeholders.(AO2)

Foreign Producers

● If the subsidy is granted on exported


goods, it will result in lowering the price
of the goods while increasing the
amount of exports.
● This is positive for domestic producers
as their revenues will increase.
● Negative for foreign producers if they
are unable to compete with the lower
price.
● Export subsidies are considered illegal.
● The World Trade Organization (WTO)
oversees these cases.

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