Lecture Notes: Understanding Subsidies in Microeconomics
Definition and Purpose of Subsidies
Subsidies: Financial assistance provided by the government to firms to lower production costs and encourage higher output.
Core Reasons for Subsidies:
Address Market Failures: Encourage consumption and production of beneficial goods/services for society (e.g., vaccinations, healthcare, education, public transport, energy-efficient resources).
Increase Affordability: Make essential goods/services affordable, especially for low-income households, by reducing market prices.
Diagrammatic Impacts of Subsidies
Market Equilibrium Shift:
Initial equilibrium at P1 (price) and Q1 (quantity).
Subsidy reduces production costs, shifting the supply curve rightwards/downwards from S1 to S1 plus sub.
New equilibrium at P2 and Q2 with reduced market price and increased quantity.
Calculating the Cost of Subsidies
Government Cost:
Determine vertical distance (value of subsidy per unit) between the two supply curves at new equilibrium (B).
Calculate cost: vertical distance (BC) x quantity (Q2), represented by area P2, B, C, D.
Producer Revenue Impact
Before Subsidy: Revenue was P1 x Q1 (area P1, A, Q1, 0).
After Subsidy: Revenue is P2 x Q2 plus the government subsidy, resulting in a large increase to area DCQ20.
Consumer Benefits and Savings
Consumer Savings:
Pre-subsidy: Consumers purchase Q1 at P1.
Post-subsidy: Purchase Q1 at reduced price P2.
Savings shown by area P1, P2, AE.
Deadweight Welfare Loss
Government intervention leads to a resource misallocation labeled as triangle A, B, C (deadweight loss).
Stakeholder Perspectives
Consumers:
Benefit from lower prices, increased consumer surplus, higher market choice.
Concerns about long-term funding (tax increases, government spending cuts, borrowing).
Producers and Workers:
Producers gain significantly from increased revenue and surplus.
Workers may benefit from higher employment due to increased production.
Governments:
Achieve objectives of market failure correction and affordability improvement.
Wary of high subsidy costs and potential producer dependency.
Monitor producer use of subsidies and address inefficiencies or misuse (paying debts, bonuses, etc.).
Conclusion
The lecture provides an understanding of subsidies, their diagrammatic impacts, stakeholder effects, and potential downsides.