1) Subsidy - MB

Question 1

what is a subsidy?

Answer 1

a grant given by the government to producers to encourage production of a good or service

Question 2

why do governments provide subsidies?

Answer 2

to increase the quantity produced and consumed of a good or service

Question 3

what are merit goods?

Answer 3

goods with positive externalities

Question 4

what type of goods tend to be subsidised?

Answer 4

merit goods

Question 5

why does a subsidy increase demand?

Answer 5

the subsidy lowers the price of the good/service

Question 6

why is the price lower when producers are given a subsidy?

Answer 6

because the subsidy is extra revenue the producer receives when the good/service is produced or bought, causing a downward pressure on prices

Question 7

what does a subsidy do than just lower prices?

Answer 7

causes the substitution effect which leads consumers buying less goods/services that cause negative externalities

Question 8

what does a subsidy do to the supply curve?

Answer 8

shifts the supply curve to the right, the fall in price leads to an extension in demand

Question 9

analysis of subsidy diagram: why can more be supplied at any given price?

Answer 9

increases supply from S0 to S1 because it reduces producers’ costs so more can be supplied at any given price

Question 10

analysis of subsidy diagram: what is the total cost of the subsidy on the diagram?

Answer 10

the subsidy is equal to P1 - P2 per unit and the total cost to the government is the area of the shaded rectangle

Question 11

analysis of subsidy diagram: causes price to fall causing…

Answer 11

price falls from P0 to P2 and there is an extension in demand, the new market equilibrium is at P2Q1

Question 12

what does the new equilibrium from the subsidy mean?

Answer 12

if the good or service is underproduced or under consumed, this new equilibrium will be closer to the social optimum where marginal cost equals marginal social benefit (allocative efficiency)

Question 13

why are subsidies good?

Answer 13

• due to creating a new equilibrium (said in other flashcard why this is good)
• this causes a gain in welfare to society
• this will reduce market failure and mean that resources are allocated more efficiently

Question 14

subsidies work well if demand is relatively price …(elastic/inelastic)

Answer 14

elastic

Question 15

why do subsidies work well if demand is relatively price elastic?

Answer 15

this means a relatively small subsidy, and a fall in price, will lead to a relatively large increase in production and consumption, and therefore an output that is closer to the social optimum allocative efficiency

Question 16

evaluation: what are the advantages of subsidies?

Answer 16

1) market based solution
2) works better if demand is relatively price elastic

Question 17

evaluation: what are the diaadvantages of subsidies?

Answer 17

1) expensive for government - opportunity cost is high, a subsidy to correct market failure may be prohibitively expensive
2) benefits may mainly accrue to producers, lowering efficiency (depends on relative PED/PES)
3) Effectiveness depends upon level of competition, lower competition means less incentive to pass subsidy to consumers

Question 18

Judgement: why does subsidy compare favourably to tax?

Answer 18

1) can encourage consumption of merit goods rather than discourage consumption of demerit goods
2) tax can fund subsidy, more effective if used together

Question 19

Judgement: why does a subsidy compare unfavourably to tax?

Answer 19

1) costs money rather than raises money, which may be implausible given limited funds available to the government
2) may undermine government objectives such as…