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Wize University Microeconomics Textbook > Government Interventions in Markets

Subsidies

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Subsidy

A subsidy is when the government gives money to firms or consumers to encourage more people to use a good or service.

Examples:
  • Universities
  • Flu shot clinics
  • Recycling companies



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Subsidy

  1. When the equation is given in the form P = ...... you have to subtract the subsidy from the supply equation and follow the same steps as a tax.
  2. In the diagram below, the price paid by consumers is
    $8
  3. The new equilibrium quantity with the subsidy is
    25
    units.
  4. The price received by producers is
    $12
  5. The amount of the subsidy is the difference between the price the producer receives and the price the consumer pays at the new quantity. In the diagram below this would be
    12 - 8 = $4
    . The consumer receives
    10 - 8 = $2
    of the subsidy and producers receive
    12 - 10 = $2
    of the subsidy


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Example: Subsidies

The demand for pencils in Pennsylvania is downward sloping and the supply is upward sloping. If the government decides to remove the existing subsidies on pencils, which of the following would occur?

A) students would pay a lower price
B) firms would receive a higher price
C) quantity sold would decrease
D) quantity sold would increase


C
With a subsidy the government gives money to the business which would cause quantity sold to increase. But, if the government removes the subsidy then the quantity would decrease back to the original equilibrium level.

Practice: Subsidies

In the market for milk, the supply is upward sloping and demand is downward sloping, Suppose that the government offers a $1 subsidy to producers for each carton of milk sold. Which of the following will occur?