1.4.1: Government Intervention in Markets (Subsidies)

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 are subsidies imposed?

Answer 2

• To solve positive externalities.
• In order to fix information gaps.

Question 3

What are the advantages of subsidies?

Answer 3

• Society reaches the social optimum output and welfare is maximised
• They can have other positive impacts, such as encouraging small businesses, bringing about equality and encouraging exports.

Question 4

What are the disadvantages of subsidies?

Answer 4

• The government has to spend a large amount of money, which will have a high opportunity cost
• As with taxes, they are difficult to target since the exact size of the externality is unknown.
• Subsidies can cause producers to become inefficient, especially if they are in place for a long time
• Once introduced, subsidies are difficult to remove