Economics Practice IA

Germany to give €1bn subsidy to boost electric cars

Electric cars provide numerous benefits towards the environment and individuals in

society. From supporting individuals to save significant amounts of money on fuel, tax and

maintenance costs, to greatly benefitting the environment, the consumption of electric vehicles is

favourable to promote sustainability. Thus, in this article, the German government decides to

grant 1bn subsidy to boost the consumption of electric cars to gain the numerous benefits it

produces. Specifically, a per unit-subsidy of 4000 euros has been placed on each electric car to

boost consumption. This is done to fix the market failure of positive externality of consumption

where there is an “underconsumption” of electric cars in the market. Electric cars are considered

to spread positive externalities as it greatly benefits the environment (a third party) such as

reducing pollution when it is consumed. The positive externality of consumption market failure

is shown in the market of electric cars:

Market of electric cars

Price S=MSC=MPC
Potential Welfare Gain

P*
P1

MSB

MPB
Q1 Q* Quantity
 In a free market diagram of electric cars, the market failure is displayed as consumption

of electric cars does not reach the socially efficient level of Q* as humans are irrational where

they have limited information of the benefits of electric cars. Thus, this indicates an

underconsumption of electric cars at Q1. Additionally, MSB is above MPB where it is a loss of

social benefit because of underconsumption, which then creates a potential welfare gain shaded

in blue. In order to reach the potential welfare gain shaded in blue and the socially efficient level

of Q*, the government is required to intervene in the market of electric cars to eliminate the

market failure.

Market of electric cars

Price S=MSC=MPC
Potential Welfare Gain

MSC + Subsidy

P3 PS
P1
P2 CS

MSB

MPB
Q1 Q* Quantity

The government can intervene by granting subsidy, which the German government did in

order to eliminate the market failure and reach closer to the socially efficient level of

consumption of Q*. With the per-unit subsidy of 4000 euros, the supply curve shifts downwards

by the subsidy amount as firms of electric cars are able to reduce cost of productions and thus,

increase supply. As electric car firms are able to reduce their cost of production, they are able to
reduce the price of each electric car from P1 to P2. The consumers are then given the incentive to

purchase more of the product as they are able to save more income (4000 euros). Because of this,

the demand curve will shift to the right due to the increase of consumption and will reach closer

to the socially efficient level of consumption of Q*, where MSB=MSC. With the subsidy,

consumption of electric cars is increased to gain a section of the potential welfare gain.

Various stakeholders will be affected due to the electric car subsidy. The shaded area of

CS and PS displays the consumer and producer surplus. Consumers are able to benefit from the

subsidy as the price of the electric cars will decrease from P1 to P2, thus increasing the consumer

surplus. On the other hand, producers are also able to benefit from the subsidy as they are able to

decrease costs of production of electric cars and supply more where they can get more sales.

Thus, producer surplus is increased. However, governments are burdened due to spending

expenditures on subsidy for electric cars, this is because the government is faced with

opportunity costs where they would need to cut their expenditures on some other areas.

Towards the long term, the subsidy is able to promote sustainability where the society as

a whole may benefit. With more consumption of electric cars, the government is able to reach

their climate goal of reducing pollution, therefore can spend less expenditures on countering

pollution. Improvement in the environment will lead towards a healthier society where

consumers will greatly benefit. The subsidy on electric cars promotes sustainability where it

pursues a healthier environment and the goal of the government with mor consumption of

electric cars. Thus, it successfully eliminates the market failure of positive externality of

consumption.