subsidies

Question 1

subsidies graph analysis

Answer 1

• subsidy can be defined as a sum of money granted by the government to help a business keep the price of a good or service low.
  1. subsidy decrease cost of production
  2. causes rightward shift in supply due to more willingness and ability
  3. extension in demand curve
  4. vertical distance between supply curves illustrates size of subsidy and per unit subsidy is same
  5. subsidy lowers market price P1-P2
  6. quantity increased Q1-Q2
  7. aims to solve underconsumption/underproduction
  8. and if market failure addressed market will be more allocatively efficient

Question 2

PED subsidy

Answer 2

1. impact of subsidy may depend on PED
2. if demand is price elastic
3. there will be decrease in price and increase in quantity demanded more proportionally
4. a 10% decrease in price could lead to 15% rise in quantity demanded for PED of -1.5
5. consequently the large rise in quantity demanded may mean that external benefits to 3rd parties may reach SOQ
6. subsidies could be effective to address market failure so may be preferable

Question 3

difficult to set at right level

Answer 3

1. however it can be difficult to set subsidy at right level
2. if subsidy is too small it may not encourage production to reach SOQ that government desires
3. If the subsidy is too large, firms may have not have strong Incentives to become less productively inefficient
4. therefore firm may fail to minimise cost per unit which leads to wastage and only fraction of subsidy is passed on in lower prices
5. furthermore, there’s a real resource opp cost to deploying factors of production in subsidised markets
6. productive labour and capital in subsidised markets could be put to better use in other markets to make them efficient

Question 4

government intervention and moral hazards

Answer 4

1. however, the policy may not always work as intended
2. for example UK gov offered £400 subsidies on household bills in 2022
3. a non targeted subsidy may reinforce demand for both renewable and non-renewable resources
4. which will continue to support firms involved in production of non-renewable resources
5. this creates a moral hazard
6. for example there’s a lack of incentive to guard against a risk where individuals are protected from consequences
7. therefore government failures occurs as a result of subsidy
8. government intervention may lead to further misallocation of resources so intervention may be preferable

Question 5

subsidy evaluative points

Answer 5

PED
difficult to set at right level
government failure and moral hazard