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

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Economics of Government Subsidies AS Microeconomics November 2009
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Should we offer subsidies for these?
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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
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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
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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)
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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
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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
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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
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97-handout - Economics of Government Subsidies AS...

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