Subsidies

Subsidies Pt1.mp4

Introduction to Subsidies

The next method of government intervention we will study is subsidies. There are a number of ways governments can offer subsidies to individuals or groups such as direct cash payments or transfer payments, direct provision of a good or service (offered for free or reduced price) or tax relief. This video will look more into production subsidies government can provide to firms in order to reduce the cost of production, increase supply and therefore lower the price in the market.

A subsidy is a financial assistance made by governments to firms or individuals. Governments may subsidise in order to:

Increase revenue for firms
Make goods more affordable to low income consumers
Encourage Production and Consumption of goods considered desirable
Support growth in a particular industry
Encourage the exports of a certain good
Can be used to correct positive externalities and improve resource allocation

The effects of a subsidy on a market

As we have seen in the previous video, the subsidy lowers the cost of production for firms. This causes a increase in the supply due to lower cost of production. The following video will discuss the impact of the imposition of an subsidy on a market. It is important to remember that unlike previously where the price consumers pay was the same as the price firms received, after the imposition of an indirect tax, we now have to identify the following:

Price Consumers Pay (Pc)
Price Producers Receive (Pp)
Value of the subsidy (Pc-Pp)
Government Expenditure (Pp-Pc)*Qsub

Subsidies Pt2.mp4

Stakeholder Analysis

The final video will look at the impacts on the various stakeholders. Up until this point, we have looked at Consumers, Producers and Society as a whole (Social or Community Surplus). The video will now look at the effects on the various stakeholders, as a result of the imposition of the indirect tax using the before and after effects of

Consumers
Producers
Government
Workers
Society as a whole

It is important to understand why, despite the benefits brought to consumers (lower prices) and producers (higher revenues) these gains are a result of the government subsidizing the production of the good and not the interactions between consumers and producers. Therefore at Qsub (Q2 in the video), MB≠MC and in fact MC>MB. As such this creates a welfare loss due to the overallocation of resources to the production of this good.

Subsidies Pt3.mp4

Calculating the effects of a subsidy

Value of the Subsidy (Pp-Pc)

Consumer Expenditure before tax = Pe x Qe

Consumer Expenditure after tax = Pc x Qsub

Producer Revenue before tax = Pe x Qe

Producer Revenue after tax = Pp x Qsub

Government Expenditure = (Pp-Pc) x Qsub

Consumer Benefit = (Pe-Pc) X Qsub

Producer Benefit = (Pp-Pe) x Qsub

Consumer Surplus before = ((Pmax - Pe) x Qe) / 2

Consumer Surplus after = ((Pmax - Pc) x Qsub) / 2

Producer Surplus Before ((Pe-Pmin) x Qe) / 2

Producer Surplus After ((Pp-Pmin) x Qsub) / 2

Welfare Loss =

(Pe - Pc) x (Qsub-Qe) + (Pp-Pe) x (Qsub-Qe)

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