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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”
ApprenLceship 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
Basic Subsidy Diagram – For Producers
Price
QuanLty / output
Supply pre subsidy
P1
Q1
A government subsidy per unit of output paid to producers causes an outward shiQ of the market supply curve leading to a lower equilibrium price and an increase in the equilibrium quanLty traded.
Demand
Supply post subsidy
P2
Q2
Subsidy
Subsidy per unit is shown by the verLcal distance
Exam Tip: Don’t forget to explain the transmission mechanism of a subsidy through lower costs of producLon
Showing Total Government Spending on the Subsidy Price
QuanLty / output
Market Supply pre subsidy
P1
Q1
Total spending on the subsidy is equal to the subsidy per unit mulLplied 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
JusEficaEons for Subsidies for Producers
Subsidies are a form of government intervenLon. They are introduced for a number of economic, social & poliEcal 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
distribuLon
Reduce some of the external costs of
transport
Encourage arts and other cultural
services
Effects of Subsidies with Different Price ElasEcity
InelasEc market demand Subsidy has a larger effect on the new
equilibrium price
Price
Qty
Price
Qty
P1
Q1
ElasEc market demand Subsidy has a stronger effect on the
new equilibrium quanLty
D1
P2
Q2
S1
S2
S1
S2 D1
Q1 Q2
P1 P2
Subsidy Subsidy
Some EvaluaEon Arguments when Assessing Subsidies
• Will they achieve the desired sLmulus to demand / consumpLon? • Is a subsidy sufficient? Might other incenLves be needed?
Are the subsidies effecLve in meeLng their aims?
• Subsidies for investment and research can bring posiLve spillovers • But firms may become dependent on state aid / financial assistance
Will a subsidy affect producLvity / 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?
Cost Benefit Analysis
• Cost benefit analysis is a process used to measure the esLmated net social rate of return from an investment project.
• When governments are deciding how much to spend on public goods, they might use a cost-‐benefit approach to aid them
• A typical cost benefit analysis involved the following process: 1. Set the key objecEves for the project 2. Set project decision criteria i.e. an acceptable benefit to cost raEo 3. IdenLfy and value the private & external costs of the project 4. IdenLfy and value the private & external benefits of the project 5. Consider possible distribuEonal effects e.g. on inequality 6. Discount annual value of benefits that will happen in the future 7. Adjust for various risks and uncertainEes 8. Consider the unvalued / non-‐moneEzed costs and benefits 9. Measure the expected net social return from the project 10. Compare with expected net social returns from other projects i.e.
the opportunity cost of £billion invested in a project
EvaluaEon: Problems with Cost Benefit Analysis
Assigning monetary values • Some aspects of a project can be
assigned a monetary value • Time savings e.g. For
passengers and businesses • OperaLng costs of the project • Value of carbon emissions e.g.
Lower CO2 from less car use • Risk of death or injury
• Other variables are much harder to assign values • Bio-‐diversity • Water quality • Air quality • Heritage • Social inclusion / accessibility
UncertainEes and Risks • There are uncertainLes involved
in major projects with long construcLon Lmes + operaLng life that can last decades • Forecast errors for passenger
numbers in different modes of transport
• UncertainLes about populaLon growth
• UncertainLes about future operaLng costs (including energy prices)
• Future business growth / types of businesses / impact of new technologies
Supporters of major projects may suffer from opLmism bias when evaluaLng a project