Subsidies

Subsidies are a payment to producers from government in order to reduce costs of production. Subsidies effectively lower the costs of production so producers supply will increase. (The supply curve moves DOWN vertically ) The vertical distance between the old supply curve and the new supply curve is the size of the subsidy The government places a subsidy on Merit Goods Merit Goods = a good the government believes is beneficial for consumers or society. E.g. Helmets. The governments aim of a subsidy is for consumption of Merit goods by consumers to increase.

Example: The government decides to place a.60c subsidy on avocados. Producers are paid.60 per for every unit sold (Avocados) The supply curve moves vertically down by.60 The new equilibrium price is the amount paid by consumers (Pc) the new equilibrium quantity is the amount consumed by consumers and produced by producers (Qe) S + Sub Amount of the subsidy Pc Qe

S + Sub Amount of the subsidy Pc Pp Q1 Producers now receive the new equilibrium price (Pc)+ the amount of the subsidy this is shown on the graph as Pp. Pe Qe

Effect of Subsidy Before the subsidy Equilibrium price =____________ Consumers pay =___________ Producers receive =___________ Equilibrium Quantity =__________ Amount Consumed =___________ Total expenditure by consumers =______________________ Total Revenue Earned by producers (PXQ) =____________________ After the Subsidy Consumers pay =_____________Producers Receive ____________ Amount consumed =_______________ Total expenditure by consumers =______________________ Total government Expenditure =____________________ Total revenue earned by producers =_________________ $ $1.80 x =$ $2.20$ $1.60 x = $ c x = $ x = $198000

Effect of a Subsidy on Consumers Consumers now pay a lower price as so increase the amount they consume. Consumers will enjoy health benefits with increased consumption of a merit good Consumers may decrease their consumption of relatively more expensive substitutes as they become more expensive than the good being subsidised. May increase the amount of complements consumed.

Effect of the Subsidy on Producers Producers receive a higher price so increase their quantity supplied Producers total revenue increases as the price they receive increases as does the quantity demanded by consumers Profits will increases as costs decreases and revenue increases. (Profit = Revenue –Costs) Producers may switch from relatively less profitable goods May employ more staff, increase production and buy more capital as the amount they produce increases

Effect of the Subsidy on Government Government has to pay firms the amount of the subsidy so their costs increase. Government may try and increase its revenue by increases taxes or decreasing government spending on other areas (e.g. health or education) With consumers purchasing more merit goods and enjoying health benefits, it may result in the government spending less on health care etc. Government may recieve more company tax as firms profits increase.

Key Formula – Subsidy Before the subsidy Price paid by consumers (Pe) = Equilibrium price Quantity consumed/sold (Qe) = Equilibrium quantity Total Spending by consumers (Pe x Qe)= Equilibrium price x Equilibrium Quantity Total revenue by producers (Pe x Qe) = Equilibrium price x Equilibrium Quantity After the Subsidy Price paid by consumers (Pc)= Equilibrium price Quantity consumed/sold (Q1) = Equilibrium quantity Amount of subsidy = Vertical distance between the supply curves. Price received by producers after subsidy (Pp)= Equilibrium price + amount of subsidy Total Spending by consumers (Pc x Q1) = Equilibrium price x Equilibrium Quantity Total Revenue earned by producers after the subsidy (Pp xQ1)= New equilibrium price + amount of subsidy x number of units sold/consumed OR Total revenue earned producers after subsidy= Total expenditure by consumers + Total subsidy paid by government Total cost of subsidy to the government = Subsidy amount x number of units sold ( new quantity)