97-handout - Economics of Government Subsidies AS...

Economics of
Government Subsidies
AS Microeconomics
November 2009

Should we offer subsidies for these?

Government subsidies
• Subsidies represent payments by the government to
suppliers that have the effect of reducing their costs
and encouraging them to increase output
• The effect of a government subsidy is to increase
supply
• Other things being equal, a subsidy on a product will
lower its price causing an expansion of market
demand
• The total amount spent on the subsidy is equal to the
subsidy per unit multiplied by total output

What is a Subsidy?
• Do subsidies enhance or worsen social welfare?
• The key in each case is to consider impact of a subsidy
on
– Economic efficiency
– Equity

Producer subsidy
• A guaranteed payment on the factor cost of a
product e.g. payments for farmers under the EU CAP
• An input subsidy which subsidises the cost of certain
inputs used in production
• Financial support – such as a grant or block payment
to cover losses made by a business (e.g. the annual
operating subsidy given to train operating
companies)

Farm subsidies
• Under the old Common
Agricultural Policy, the EU
provided direct payments
to producers based on
output
• This has now changed
• Most farmers now receive
a single income payment

Consumer subsidy
• A government payment to consumers designed to
allow them to purchase more of a good or service
• Might take the form of
– Interest free loans (an effective subsidy)
– Direct grants
• Note: Consumer subsidies affect the level of demand
instead of shifting the supply curve

Main Aims of Subsidies (1)
• Keep market prices down (i.e. to raise real incomes
of buyers)
• Boost market demand for certain goods and services