What this lesson teaches
I can describe taxes, subsidies, price controls and quotas as ways a government intervenes in a market.
Syllabus 9570, 2.1.3(a). Government Intervention in Markets: Governments may intervene in markets in the form of taxes, subsidies, price controls (maximum and minimum prices) and quantity controls (quotas)
Make a guess
The government pays producers $2 for every unit of a good they sell. What happens to the total cost of the subsidy as sales rise?
- It falls, because the good becomes cheaper to make.
- It rises, because $2 is paid on every extra unit sold.
- It stays at $2, the amount set by the government.
Show the answer
It rises, because $2 is paid on every extra unit sold.
The subsidy is per unit. By lowering the price, it raises sales, and each extra unit adds $2 to the bill.
A subsidy shifts supply down by the subsidy, so buyers pay less, sellers get more and more is sold.
A subsidy is a payment from the government to producers for each unit they sell. It lowers their costs.
So the supply curve shifts down by the subsidy, from S to S1. At the old price there is a surplus, and the price falls.
At the new equilibrium, buyers pay less (P1) and more is sold (Q1). Sellers receive the price plus the subsidy (P2). The government pays the subsidy on every unit sold.
Singapore subsidises public healthcare and public transport, so users pay less than the full cost of the service.
- Buyers
- Pay less (P1).
- Sellers
- Receive more (P2 = P1 + subsidy).
- Government
- Pays subsidy x Q1.
Worked example: A $2 subsidy on bottled water
Before the subsidy, 80 bottles a day sell at $6. After a $2 subsidy per bottle, 100 bottles sell at $5.
- Buyers pay $5, $1 less than before.
- Sellers receive $5 from the buyer plus $2 from the government: $7 a bottle.
- The government pays $2 x 100 = $200 a day.
- The cost to the government grows as more is sold, so a popular subsidy can become expensive.
Watch out for this
A $2 subsidy costs the government $2.
The subsidy is $2 per unit. The total cost is $2 times the quantity sold, which rises as the subsidy increases sales.
Check your understanding
After a $3 subsidy per unit, 500 units are sold each week. What does the subsidy cost the government each week?
- It depends on the price buyers pay.
- $3.
- $1,500.
Show the answer
$1,500.
Right. $3 per unit times 500 units.