subsidy and mkt failure Flashcards
what is a subsidy
money grnat given to firms by gov to lower costs of prodcution and encourage an increae in otuput
what mkt fialrue can subsidies solve
underproduction and underconsumption at work
merit goods
+ve externalities of consumption/production
give exampels of positive externalities in consumption / demerit goods
buses/trais
vaccines in hong kong
solar panels
hybrid cards
explai how subsidy works in +ve externalities of consumption
mpc shifts right as subsideies lower a firm COP
assume subsidy is eprfect so new mpc curve hits mpb at socially optimum levels
quantity increases from q1-q*
mpc cuts mpb@q* and there is a lower price
how do we dra subsidy on +ve external of consukption
draw pe consumption graph
msb higher thna mpb
draw mpc+sub right shift
price decrease
give examples of positive externalities in production
research and development + invwork training
explain how subsidies work in +ve externalities of production
mpc shifts right
assuming its a perfect subsidy
mpc shifts left to equal msc
now increases uantity to q* - now producing thter
reduction in proce from p1 tp p*
overall what do subsidies do
decreae cop
decrease price increase quanitity in mkt
solves uc and up issues as we’ve reached q*
therfore hit allocative efficiency and see welfare being maximised in the mkt
but we’ven= made lots of assumptions that dont hold in real world what are th 4
cotsly
encourage dependency
assume gov got perfect info to set subsidy at right elvel
how firms use subsidy
price inelastic demand
how do we know cost of subsidy is huge
differnce between two supply curves x quantitiy of cost
FRICKING GIGANTIC
explain issue of costly subsidies
if money is borrowed = future tax icreases this is a burden to the poor
+debt interest paid big oc - money could be used for suttin else
could mean custs in spending in the future = e.g public services such as education and healthcare is undesirable as not socially desirable
oc cost of finance is this the best use of public money
yes if its a huge mkt failure
no if extent of mkt failure is limited - couldbe been spent elsewhere in the econ
+ every firm is eleigible for subsidy increasing cop
expalain negative of maybe not setting subsidy at the right level
gov could lakc infor as not experts on the mkt
so fail to calc value of +Ve ex
so menas under/over subsidy
undersub = dont really oslve mkt failure
oversub = costs will be so much , guarantedd ov failure
explai why subsidies can encourage dependency
meaning less inovation and less incetive to reduce costs
so can allow costs to rise as subsidy covers them which is likely
lr dependsency is likel as easy way to allow uncontrollabe costs knowing subsidy will always cover it
when sub taken awat firm cant survive
explain probelm of how firm mayuse subsidy
instead of lowering costs of prodcution and psasing on savings to consumers tp increase QD
could pay off debts , icnrease salary of workes , save sub in bank , pay hgiher dividends to sh
so dont lwoer cop and dont lower prices etc
this is gov failrue as wont be singificant benefits of using but huge ccots invlved
explain the arguemtn of price elastic deamdn
need elastic demand to as lower price = higher qd enough to solve mkt failure
if inelasic e.g tfl
those uing tfl wont suddenly use it more therfore QD wont increase drastically
those not using tfl may not be encouraged to switch cause dont use tfl cause dont like inflexibiliy quality
so thats why prefer to use their car
so wont work if inelastic
with gym membership fruits price may not be reason why people dont consume other reasons e.g conveniencec
