Subsidy w/Market Failure

• Subsidy


  Money grant given to producers by the government to lower cost of production and encourage an increase in output or quantity
• Market failures solved by subsidies

  • Under consumption
  • Under production
• How a subsidy solves market failure

  1. Lowers marginal private cost curve

  2. Shifts MPC curve to equal MSC

  3. Increases quantity

  4. Reduces price
• Subsidy lowers cost of production

  Marginal private cost curve shifts to the right
• Marginal private cost curve shifts to the right

  Quantity increases and price decreases
• Subsidies are very costly to the government
• Subsidies can lead to future tax rises or spending cuts that burden the poor
• Subsidies have an opportunity cost - the money could have been spent more productively elsewhere
• Governments lack perfect information to set subsidies at the optimal level
• Firms may become subsidy-dependent and not pass on cost savings to consumers
• Subsidies can create long-run dependency for firms
• Subsidies are most effective with price inelastic demand
• Subsidies may not increase quantity consumed for goods with price inelastic demand (e.g. public transport, fruit/vegetables, gym memberships)