Producer and

Consumer
Subsidies
 Producer Subsidies
• A subsidy is a payment by the government to
suppliers that reduce their costs of production
and encourages them to increase output
• and lowering the price paid by consumers,
causing them to buy more
• State subsidises are financed from general
taxation or by borrowing
• The subsidy causes the firm's supply curve to
shift to the right
• The amount spent on the subsidy is equal to the
subsidy per unit multiplied by total output
 Examples of subsidies
• A payment on the factor cost of a product – e.g. a
guaranteed minimum price offered to farmers such as
under the old-style Common Agricultural Policy (CAP).
• An input subsidy which subsidises the cost of inputs
used in production – e.g. an employment subsidy
• Government grants to cover losses made by a business
– e.g. a grant given to cover losses in the rail industry
or a loss-making airline
• Bail-outs e.g. for financial organisations in the wake of
the credit crunch
• Financial assistance (loans and grants) for businesses
setting up in areas of high unemployment
Analysing the effects of a subsidy
Costs and
Benefits Supply pre subsidy

A
Supply post subsidy

Demand

B Output
Analysing the effects of a subsidy
Costs and
Benefits Supply pre subsidy

A
Supply post subsidy

Demand

B D Output
 Analysing the effects of a subsidy
Costs and
Benefits Supply pre subsidy
Supplier
E
receives C
A
Supply post subsidy
Consumer
C
pays B

Demand

B D Output
 Analysing the impact of a subsidy on
market outcome
Costs and
Benefits Supply pre subsidy
Supplier
E
receives C
A
Supply post subsidy
Consumer
C
pays B
Subsidy
payment

Demand

B D Output
Consumer and producer surplus
Market price and quantity before the subsidy is P1 and Q1
Price

S1 pre subsidy

S2 post subsidy
P1

Demand

Q1 Output
Consumer and producer surplus
Consumer surplus is area ABP1
Price

A S1 pre subsidy

S2 post subsidy
B
P1

Demand

Q1 Output
Consumer and producer surplus
Producer surplus = area P1BC
Price

A S1 pre subsidy

S2 post subsidy
B
P1

C
Demand

Q1 Output
Consumer and producer surplus
The subsidy causes a fall in market price to P2
Price

A S1 pre subsidy

S2 post subsidy
B
P1
P2

C
Demand

Q1 Q2 Output
Consumer and producer surplus
Consumer surplus increases to area ADP2
Price

A S1 pre subsidy

S2 post subsidy
B
P1 D
P2

C
Demand

Q1 Q2 Output
Consumer and producer surplus
Producer surplus boosted through the subsidy payment
Price

A S1 pre subsidy
E
P3 S2 post subsidy
B
P1 D
P2

C
Demand

Q1 Q2 Output
 Why government grant subsidies
• It can be used to increase revenues of producers.
• It can be used to make certain (necessities) goods
affordable to low income consumers
• Can be used to encourage production and
consumption of particular goods and service that are
believed to be desirable for consumers
• Can be used to support the growth of particular
industries in an economy
• Can be used to encourage exports of particular goods
• Method to improve the allocation of resources by
reducing allocative inefficiency by correcting positive
externalities.
 Consequences of subsidies on
stakeholders
• Consumers
• Producers
• Government
• Workers
• Society as a whole
• Foreign producers
 Arguments for Subsidies

Controlling price Boost employment Improve human capital

inflation e.g. food prices especially in poor areas and productivity

Protect strategic / Promote growing Improve affordability for

infant industries demand for renewables low-income families
 Arguments for Subsidies

Controlling price Boost employment Improve human capital

inflation e.g. food prices especially in poor areas and productivity

Protect strategic / Promote growing Improve affordability for

infant industries demand for renewables low-income families
 Arguments for Subsidies

Controlling price Boost employment Improve human capital

inflation e.g. food prices especially in poor areas and productivity

Protect strategic / Promote growing Improve affordability for

infant industries demand for renewables low-income families
 Arguments for Subsidies

Controlling price Boost employment Improve human capital

inflation e.g. food prices especially in poor areas and productivity

Protect strategic / Promote growing Improve affordability for

infant industries demand for renewables low-income families
 Arguments for Subsidies

Controlling price Boost employment Improve human capital

inflation e.g. food prices especially in poor areas and productivity

Protect strategic / Promote growing Improve affordability for

infant industries demand for renewables low-income families
 Arguments for Subsidies

Controlling price Boost employment Improve human capital

inflation e.g. food prices especially in poor areas and productivity

Protect strategic / Promote growing Improve affordability for

infant industries demand for renewables low-income families
India and Food Subsidies
India is introducing a policy
aimed at providing subsidised
food to two thirds of the
population.

The new food security law will

provide five kilos of cheap grain
every month to nearly 800
million Indians.

Can a new food law solve as

long-running problem or will it
drain the country's finances?
The government says that
money is not a problem.
 Thailand and Rubber Subsidies
Thailand has doubled subsidies to rubber farmers.
The Thai cabinet on Tuesday approved the
assistance of 21.2bn baht ($659m) to rubber
smallholders, after a dispute that has led to
shipment delays and to scuffles between police
and farmers demonstrating in the south.

Thailand is a leading world exporter of both

rubber and rice, but has faced problems managing
both industries as state financial support
programmes have led to the build-up of
stockpiles.

The Thai government’s expanding commodity

subsidy programme is in part an effort to bolster
the income of farmers at a time of falling world
prices. Natural rubber prices have almost halved
since the peak of February 2011

Source: News reports, October 2013

Is there a case for a NEET subsidy?
• The number of young people
not in education, employment
or training in the UK was 1.07m
people aged 16 to 24 in the 3rd
quarter of 2013
• Youth Contract launched in 2011
– it offers internships, work
experience and subsidies for
businesses to take on new
employees.
• But few companies are taking up
the offer of wage subsidies. In
the first year of the scheme –
designed to fund jobs for
160,000 people over three years
– it was used to employ fewer
than 5,000 young people
Source: News reports, Oct 2013
Child care subsidies – a way forward?
Britain ranks 15th out of 25 OECD nations for maternal
employment, languishing behind Germany, France,
Canada and the USA

In New Zealand – the government offers subsidies for in-

home nanny services. The childcare rebate (subsidy)
currently provides parents with 50% of their childcare
costs up to a total of $7,500 a year for each child.

With the UK childcare voucher scheme, an average

family with two working parents claiming vouchers can
save up to £1,866 a year towards their childcare costs if
both parents buy vouchers but only if their employer has
signed up to a scheme
End to UK biomass subsidy
Biomass subsidies have increased demand
for wood, pushing prices higher
Price of
S1
Timber

P2

P1

D2

D1
Q1 Q2 Quantity
of Timber
Evaluation – Criticism of Subsidies

Distortion of market Risk of fraud from Expensive – high cost

prices / incentives subsidy payments for taxpayers

Inequitable – many rich Protects inefficient

Environmental damage
people may benefit businesses
Evaluation – Criticism of Subsidies

Distortion of market Risk of fraud from Expensive – high cost

prices / incentives subsidy payments for taxpayers

Inequitable – many rich Protects inefficient

Environmental damage
people may benefit businesses
Evaluation – Criticism of Subsidies

Distortion of market Risk of fraud from Expensive – high cost

prices / incentives subsidy payments for taxpayers

Inequitable – many rich Protects inefficient

Environmental damage
people may benefit businesses
Evaluation – Criticism of Subsidies

Distortion of market Risk of fraud from Expensive – high cost

prices / incentives subsidy payments for taxpayers

Inequitable – many rich Protects inefficient

Environmental damage
people may benefit businesses
Evaluation – Criticism of Subsidies

Distortion of market Risk of fraud from Expensive – high cost

prices / incentives subsidy payments for taxpayers

Inequitable – many rich Protects inefficient

Environmental damage
people may benefit businesses
Evaluation – Criticism of Subsidies

Distortion of market Risk of fraud from Expensive – high cost

prices / incentives subsidy payments for taxpayers

Inequitable – many rich Protects inefficient

Environmental damage
people may benefit businesses
 Do
subsidies
hold back
innovation?
 Surpluses
can lead to
excess
capacity
and long
term
damage –
the EU
fishing
industry is
an example
Short term and long term effects
“In general, subsidies
should be employed to
change behaviour and
solve specific problems
rather than to serve as a
long-term crutch for
producers. If not, it will
stifle innovation and make
producers both less
competitive and more
dependent on
government.”
Source: Jason Clay, Guardian,
August 2013
Renewable Energy & Solar Subsidies
Consumer Subsidies: Feed-In-Tariffs
Using cross-elasticity of
demand, assess the likely
relationship between the
demand for solar panels
and the price of
household electricity
from non-renewable
sources
Rising electricity
prices

Incentives to
switch to
renewable energy

There is a cost to
switching

Rising market
demand for solar
panels
Despite a strong rise in demand, the market price of solar panels
has fallen in recent years. With the help of a supply and demand
diagram, explain why this can have happened
Price of
solar S1
panels

P1

D1

Q1 Quantity
Despite a strong rise in demand, the market price of solar panels
has fallen in recent years. With the help of a supply and demand
diagram, explain why this can have happened
Price of
solar S1
panels

P1

D1
D1

Q1 Quantity
Despite a strong rise in demand, the market price of solar panels
has fallen in recent years. With the help of a supply and demand
diagram, explain why this can have happened
Price of
solar S1
panels
P2

P1

D2
D1

Q1 Quantity
Despite a strong rise in demand, the market price of solar panels
has fallen in recent years. With the help of a supply and demand
diagram, explain why this can have happened
Price of
solar S1
panels
P2

P1
S2

D2
D1

Q1 Quantity
Despite a strong rise in demand, the market price of solar panels
has fallen in recent years. With the help of a supply and demand
diagram, explain why this can have happened
Price of
solar S1
panels
P2

P1
S2
P3

D2
D1

Q1 Quantity
Despite a strong rise in demand, the market price of solar panels
has fallen in recent years. With the help of a supply and demand
diagram, explain why this can have happened
Price of
solar S1
panels
P2

P1
S2
P3

D2
D1

Q1 Q2
 Evaluate the argument for
government intervention in the
market for solar panels to encourage
the growth of renewable energy
rather than allowing free market
forces to operate
The case for solar subsidies
Promotes renewable energy and
lowers oil dependency

Creates thousands of new jobs – + a

positive multiplier effect

Cuts bills for consumers & councils

Economies of scale if the take-up of

panels increases
Solar subsidies – critical evaluation
Subsidies benefit richer households

Limited effectiveness for money

spent – opportunity cost

Mis-selling of solar panels especially

to vulnerable households

Most solar panels are imported