- A subsidy is opposite to a tax. It is money given by the government to encourage the consumption and production of certain goods.
- This works something like this : (i) Producers are given money to help them cover costs -> (ii) Costs decrease for producers -> (iii) This increases supply of the good -> (iv) This will decrease the price of the good ->(v) This will increase demand/consumption of the good.
- Subsidies can also be given to stabilise price, cut down domestic costs of production so that imports are reduced.
A subsidy diagram:
(Diagram produced by Komilla Chadha)
Click on the diagram to enlarge it!
So this diagram shows a subsidy.
- It shows that price has decreased
- It shows the quantity has increased
- The red arrow shows the subsidy per unit
- To get the full subsidy given by the government we multiply subsidy per unit by quantity so the blue rectangle [p1p2(purple dot)(point vertically above purple dot)] is the total subsidy in this image.
- The orange square within the total cost of the subsidy is what amount of the subsidy the producer keeps.
- The yellow part of the subsidy is what effect the subsidy has had on consumers.
- The amount producers and consumers feel all depend on the elasticity of the good.
This is video by an amazing economics teacher explaining subsidies: