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Tutor2u - Government Intervention – Subsidies

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Exam questions involving drawing subsidy diagrams are typically found demanding by many students so please remember to revise this area of the course properly and get in lots of practise for this type of government intervention. If your analysis is accurate, you will frequently be given plenty of scope to critically evaluate the role of subsidies particularly when it comes to addressing different types of market failure. Strong evaluation understands the importance of elasticity in assessing the impact and also considers alternatives to subsidies by the government.

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Tutor2u - Government Intervention – Subsidies

  1. 1. Government Intervention – Subsidies
  2. 2. Government Intervention in Markets Subsidies
  3. 3. Government Subsidies for Producers and Consumers A subsidy is any form of government support—financial or otherwise—offered to producers and (occasionally) consumers Biofuel subsidies for farmers Solar Panel Feed- In Tariffs Apprenticeship Schemes Aid to businesses making losses Subsidies for wind farm investment Food / fuel subsidies for consumers Child Care for working families Subsidies to the rail industry
  4. 4. Basic Subsidy Diagram – For Producers Price Quantity / output Market Supply pre subsidy P1 Q1 A subsidy per unit of output causes an outward shift of the market supply curve leading to a lower equilibrium price Market Demand Market Supply post subsidy P2 Q2 Subsidy Subsidy per unit is shown by the vertical distance
  5. 5. Showing Total Government Spending on the Subsidy Price Quantity / output Market Supply pre subsidy P1 Q1 Total spending on the subsidy is equal to the subsidy per unit multiplied by the level of output – shown by the shaded area Market Demand Market Supply post subsidy P2 Q2 P3 Producer receives this price Consumer pays this price
  6. 6. Justifications for Subsidies for Producers Subsidies are a form of government intervention. They are introduced for a number of economic, social & political reasons Help poorer families e.g. food and child care costs Encourage output and investment in fledgling sectors Protect jobs in loss- making industries e.g. hit by recession Make some health care treatments more affordable Reduce the cost of training & employing workers Achieve a more equitable income distribution Reduce some of the external costs of transport Encourage arts and other cultural services
  7. 7. Effects of Subsidies with Different Price Elasticity Inelastic market demand Subsidy has a larger effect on the new equilibrium price Price Qty Price Qty P1 Q1 Elastic market demand Subsidy has a stronger effect on the new equilibrium quantity D1 P2 Q2 S1 S2 S1 S2 D1 Q1 Q2 P1 P2 Subsidy Subsidy
  8. 8. Evaluation Arguments when Assessing Subsidies • Will they achieve the desired stimulus to demand / consumption? • Is a subsidy sufficient? Might other incentives be needed? Are the subsidies effective in meeting their aims? • Subsidies for investment and research can bring positive spillovers • But firms may become dependent on state aid / financial assistance Will a subsidy affect productivity / efficiency? • Is a subsidy part self-financing? Will it create more tax revenue? • Or does a subsidy create an expensive extra burden for taxpayers? How much does the subsidy cost and who benefits? • For example – do more people find work with child care subsidies? • Or does a subsidy lead to undesired / unintended consequences? Does the subsidy help to correct a market failure?
  9. 9. Get help from fellow students, teachers and tutor2u on Twitter: @tutor2u_econ
  10. 10. Tutor2u Keep up-to-date with economics, resources, quizzes and worksheets for your economics course.

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