A2.04.04: Subsidies

Question 1

Define subsidies

Answer 1

Fixed payments per unit of output made by the gov. to firms and these are given to producers before they sell the product at a lower price

Question 2

List 6 ways in which subsidies can be used

Answer 2

• Increase incomes of producers (I)
• encourage merit goods (M)
• improve the allocation of resources (A)
• support the growth of industries (G)
• encourage exports (E)
• make necessities affordable (N)

(IMAGEN)

Question 3

Explain how subsidies can increase the income of producers

Answer 3

Subsidies increase revenues of producers thus, gov often grant subsidies to particular producers whose revenues (and thus, incomes) they would like to support - this is most commonly done for producers of agricultural products

Question 4

Explain how subsidies make necessities affordable

Answer 4

Subsidies lower the prices of the goods paid by consumers thus, making the goods more affordable. A gov. may wish to make a food staple (rice or bread) more affordable to low-income earners and can do so by granting a subsidy to producers of the good

Question 5

Explain how subsidies can encourage merit goods

Answer 5

Subsidies can encourage production and consumption of merit goods that are believed to be desirable for consumers. This is because it can increase the quantity of a good produced and consumed. A gov. may wish to encourage consumption of a good as it’s considered to be desirable

Question 6

Explain how subsidies can support the growth of industries

Answer 6

As subsidies increase the quantity of output produced, if granted to firms in a particular industry, they support the growth of that industry. For instance, subsides to the solar industry are intended to promote the growth of solar power.

Question 7

Explain how subsidies can encourage exports

Answer 7

As subsidies lower the prices paid by consumers, they are sometimes granted on goods that are exported, since lower export prices increase the quantity of exports.

Question 8

Explain how subsidies can improve the allocation of resources

Answer 8

Subsidies can reduce allocative inefficiencies by correcting positive externalities thus, improving allocative efficiency

Question 9

Define a rebate

Answer 9

a partial refund of the cost of an item like a buyer discount

Question 10

How can a subsidy be given to the consumer

Answer 10

After the consumer buys the product in the form of a rebate (on discount). Producers also benefit as it can build consumer loyalty

Question 11

How does the subsidy diagram look

Answer 11

• rightwards shift of supply labelled (S1 + Subsidy)
• Consumer incidence (benefits): p1peFB (B is the intersection between second supply curve and D, F is on the middle of the base of DWL triangle)
• Producer incidence (benefits): p2peCF (C is the point above F)
• Gain in subsidy is p1p2CAB (not considering DWL)

Question 12

Explain how third parties are affected

Answer 12

Consumers: winners
- They pay lower prices and consume a higher quantity thus, having greater choice

Workers: winners
- more output means greater employment and potentially higher wages (however if an industry has too many workers, wages may be low)

Producers: winners
- producers receive higher prices, sell a greater quantity, make greater supernormal profits and therefore, higher revenues

Governments: losers
- opportunity cost and this subsidy may cause governments to tax more (indirect taxes are regressive and affect low-income households more than higher income households)

Society:
- overproduction and DWL occurs