Subsidies

Who can gain from a subsidy?

Producers and Consumers

Advantages of Subsidies

+ The benefit of goods with positive externalities is internalised, i.e. the cost of these externalities is covered by the government subsidy, so the price of the goods is reduced from what it would be in the absence of the subsidy + Subsidies can change preferences - producers will supply goods with +ve externalities and consumers will consume them and receive the benefits from them. Also, making a merit good cheaper by the presence of a subsidy makes it more affordable and increases demand for it + Positive externalities are still present. E.g. if a subsidy is paid for wind farms, the wind farms will still reduce pollution levels

Disadvantages of Subsidies

- Can be difficult to put a monetary value on the 'benefit' of the positive externalities - Any subsidy has an opportunity cost, the money spent on it might be better spent on something else - Subsidies may make producers inefficient and reliant on subsidies. The subsidy means that producers have less incentive to reduce costs or innovate - Effectiveness of subsidies depends on the elasticity of demand - subsidies wouldn't significantly increase demand for price inelastic goods - The subsidised goods and services may not be as good as those they're aiming to replace. E.g. imported goods may be better quality than the domestically produced alternatives a subsidy is promoting

What is a subsidy?

A subsidy increases the supply of a good/service, so the supply curve shifts to the right

What is the governments aim when distributing subsidies?

Aim to encourage the production and consumption of goods and services with positive externalities such as merit goods