Published on September 21, 2013
Subsidies : Subsidies Demand & Supply IB DP Economics SL PowerPoint Presentation: Impact of subsidies on supply curve D S 1 S 1 - subsidy Qe Pe Quantity Price ($) Q1 P1 0 Percentage subsidy is rare. So specific subsidy is discussed. A specific subsidy is a specific amount of money that a government gives to a firm for each unit of the product. For example: $2 per unit. It makes the supply curve shifts vertically downwards by the amount of the subsidy. In this case $2 at every price. S 1 is the original supply curve and S 1 – subsidy is the curve after the subsidy is granted. $2 PowerPoint Presentation: What happens to the supply curve when subsidies are granted? D S 1 S 1 - subsidy Qe Pe Quantity Price ($) Q1 P1 0 In a normal demand & supply curve, when the government grants a specific subsidy on a product, it looks something like this curve. PowerPoint Presentation: Subsidies & producer revenue D S 1 S 1 - subsidy Quantity Price ($) 0 Qe Pe Q1 P1 The market is in equilibrium with Qe being supplied and demanded at price Pe . After the subsidy of WZ per unit is granted, the supply curve shifts vertically downwards from S1 to S1 – subsidy. Here producers lower their prices and increases output until a new equilibrium is reached, which is at a price of P1, where Q1 is quantity both supplied and demanded. W Here we see that price to consumers falls from Pe to P1, which is not the whole amount of subsidy. To make it equal to the subsidy, it should fall to P2. P2 How this benefits producers? The income of producers rises from original amount of 0PeXQe to 0DWQ1. D X Z What happens to the consumers benefit? How this benefits producers? PowerPoint Presentation: Subsidies & consumer expenditure and government subsidy D S 1 S 1 - subsidy Quantity Price ($) 0 Qe Pe Q1 P1 W P2 What happens to consumers benefit? Consumers expenditure reduces from 0PeXQe to 0P1ZQ1 What happened to price? What happened to quantity demanded and supplied (received)? D X Z P1DWZ is paid to the producers by the government as the subsidy on the Q1 units. PowerPoint Presentation: Subsidy & consumer gain & extra spending D S 1 S 1 - subsidy Quantity Price ($) 0 Qe Pe Q1 P1 W P2 What happens to consumers benefit? Consumers get to buy the original Qe units, not at the price of Pe , but at the lower price P1. This is their gain. Thus saving P1PeXY. D X Z Y But with the savings they are doing (with lesser price), do they demand less as before? No. They demand/purchase more units, QeQ1, because price is lower. Though for this extra unit they need to spend QeYZQ1 extra. BUT This total consumer expenditure may increase or fall, depending upon the relative savings and extra expenditure. PowerPoint Presentation: Opportunity cost for granting subsidy D S 1 S 1 - subsidy Quantity Price ($) 0 Qe Pe Q1 P1 W P2 From who’s pocket does this subsidy comes from? D X Z Y P1DWZ subsidy Opportunity cost for this subsidy? Take away money from other areas of expenditure, such as building infrastructure or providing public amenities. OR Raise taxes.