IB Economics - 4.3 Subsidies

What are the different forms that a subsidy may take?

A subsidy may take few forms: 1 - Low-interest or interest-free loans 2 - Provision of goods and services below market prices 3 - Paying low or no taxes 4 - Direct cash-payments (focus of this chapter)

What are the 4 additional considerations when granting a subsidy?

1 - Government Opportunity Cost: The opportunity cost of government spending on the subsidy in terms of other alternative spending projects. 2 - Does it create Inefficiencies? The subsidy allows firms to be inefficient if they do not have to compete with foreign producers in a "free market". 3 - Who is going to pay for it? Although the subsidy allows consumers to buy products at a lower price, the taxpayers are who are funding the subsidy. So, is it really cheaper? 4 - Is there damage to foreign producers? This is a complex debate between high-income and low-income countries. Example = High-income countries subsidize their farms, thus, leading to overproduction of goods that could have been produced in other countries more cheaply, but because of subsidies it's not the case.

Why do governments grant subsidies to firms? Give examples. There are 6 reasons.

1 - Governments often grant subsidies to particular producers to support them and increase their revenues. Example = Government subsidies are common for agricultural producers. 2 - Subsidies can be used to make certain goods (necessities) affordable to low-income consumers. Example = A government may wish to make a food staple (such as bread or rice) more affordable to low- income earners and can do so by granting a subsidy to producers of the good. 3 - A government may provide subsidies to producers to make a product more desirable to consumers. Example = Common examples are vaccinations and education, which are things that are considered to be desirable. 4 - Subsidies can be used to support the growth of particular industries in an economy. By providing subsidies governments can support specific industries to increase its output. Example = Subsidies to the solar industry are intended to promote the growth of solar power. 5 - Subsidies can be used to encourage exports of particular goods. As subsidies lower the price paid by consumers, it is at times, applied to exported goods to increase the quantity of exports and receive a competitive pricing. Example = Bangladesh's garment industry is heavily subsidized so that it is competitive on a global scale. 6 - Subsidies are a method to improve the allocation of resources (reduce allocative inefficiencies) by correcting positive externalities. Subsidies can be used to try to improve the allocation of resources. Example = If there is not a lot of education in the country, it could be subsidised, increasing the quantity supplied and demanded of the service, and consequently improving allocative efficiency as it corrects the positive externalities (increases output, there is more of it).

What is a subsidy?

A subsidy, in a general sense, refers to assistance by the government to individuals, to firms, to consumers, to industries, or sectors of an economy. Specific subsidies are usually given as a fixed amount of subsidy per unit of output in the form of direct cash payments.

How can subsidies increase or decrease allocative efficiency?

Same as indirect taxes, subsidies either improve or worsen the allocation of resources. If an economy starts off with allocative efficiency, the imposition of a subsidy will cause allocative inefficiency and welfare loss. But, if the economy starts off with allocative inefficiency, then a subsidy can work to improve the allocation of resources.

As a stakeholder, how are foreign producers impacted by subsidies on export goods?

Subsidies allows firms to export items at a lower price, and also increase its quantity of export. This is positive for the domestic producers, but negative for the producers from other countries, who are unable to compete with the subsidized goods.

Why are subsidies sometimes controversial?

Subsidies can sometimes be a controversial subject, as they are set out to achieve certain objectives that may contradict other important objectives. Thus, there is a high level of opportunity cost to it for governments.

How do subsidies change the allocation of resources?

Subsidies, like taxes, change the allocation of resources because they affect relative prices. Thus, they change the signals and incentives prices convey.