Subsidy & Linear

Functions
Unit 4.1 - Lesson 5

Learning outcomes:
Plot demand & supply curves from a linear
function and then illustrate and calculate the
effect of a subsidy on market price & the
benefit and costs to stakeholders.

Calculating Effect of Subsidy

Given:

Qd = 60 2P
Qs = 20 + 2P

Government grants, per unit subsidy of $4. Calculate:

1.
2.
3.
4.
5.

Producer Gain
Consumer Gain
Cost of Subsidy to the government
Consumer Surplus gain after subsidy
Producer surplus gain after subsidy

Steps:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.

Calculate the Equilibrium Price & Quantity.

Calculate the P-intercepts for Supply/Demand.
Graph your Supply & Demand Function.
Write the new equation with showing a $4 subsidy.
Calculate the new equilibrium Price, Quantity & P-int.
Graph the new Supply curve.
Calculate the Producer gain.
Calculate the Consumer gain.
Calculate cost of Subsidy to the Government.
Calculate amount of CS & PS gain due to the subsidy.

Step 1:
Qs = Qd
60 - 2P = -20 +2P
80 = 4P
P = 20

P = 20
Qs = -20 + 2P
Qs = -20 + 2(20)
Qs = -20 + 40
Qs = 20

The Equilibrium Price and Quantity are $20

and 20 units

Step 2:
The Price-intercept is the price when quantity is
0. Set Qs & Qd = 0.
Qs = -20 +2P
0 = -20 + 2P
20 = 2P
P = 10

Qd = 60 - 2P
0 = 60 - 2P
2P = 60
P = 30

Step 4:
Write the new supply function reflecting the $4
per unit Subsidy
Qs = -20 +2P
Qs = -20 + 2(P + 4)
Qs = -20 + 2P + 8
Qs = -12 + 2P

Step 5:
Qs+subsidy = Qd
60 - 2P = -12 + 2P
4P = 72
P = 18

Qd = 60 - 2P
Qd = 60 - 2(18)
Qd = 60 - 36
Qd = 24

Consumer & Producer Price

Price the Consumer Pays = $18
Producer Receives amount the Consumer
pays + the amount of Subsidy
$18 + 4
Price the Producer Receives = $22

Step 7: Producer Gain

Producer Gain:
Area of Rectangle + Area of Right Triangle
Area of Rectangle: (22 - 20) x 20 = 40
Area of Triangle: (22 - 20) x 4 divided by 2
8 divided by 2 = 4
Producer Gain: 40 + 4 = 44

Step 8: Consumer Gain

Area of Rectangle + Area of Right Triangle
Area of Rectangle: (20 - 18) x 20 = 40
Area of Right Triangle:
(25 - 20) x 2 divided by 2
8 divided by 2 = 4
Consumer Gain: 40 + 4 = 45

Consumer & Producer Gain

The Consumer and Producer Gain are the
same.
When the Price coefficient is the same, the
producer and consumer gain will be equal.

Step 9:
Cost to the Government = (P2 - P1) x Q1
(22 - 18) x 24
4 x 24
96
Cost of the Subsidy is 96

Total Welfare Loss

Area of the Right Triangle
(22 - 18) x 4 divided by 2
16 divided by 2
Total Welfare Loss = 8

Step 10:
CS before tax =
(Qd p-int - Pe) x Qe
2
(30 - 20) x 20
2
10 x 20
2
CS before tax = 100

CS after tax =
(Qd p-int - P1) x Q1
2
(30 - 18) x 24
2
12 x 24
2
CS after tax = 144
Consumer Surplus gain is
44

Step 10:
Producer Surplus before tax:
(Pe - Qs p-int) x Qe
2
(20 - 10) x 20
2
10 X 20
2
PS after tax is 100

Producer Surplus after tax:

(P1 - Qs + subsidy p-int) x Q1
2
(18 - 6) x 24
2
12 x 24
2
288
2
PS after tax is 144
PS gain is 44