1.4.2 Subsidies

Question 1

Define a subsidy

Answer 1

Any form of government support - financial or otherwise - offered to producers and (occasionally) consumers

Question 2

Suggest the market failure that subsidies could be used to correct

Answer 2

Positive externality of consumption leading to underconsumption.

Question 3

How do subsidies correct market failure

Answer 3

Lowers cost of production, leading to lower prices for consumers and increased consumption

Question 4

What is the effect of a subsidy on the supply curve

Answer 4

Shifts outwards as it lowers the cost of production

Question 5

How do subsidies maximise social welfare

Answer 5

The market now produces at the output that best allocates resources aka social optimum (MSC=MSB) rather than MPC=MPB