Page 2: Subsidies and Minimum Prices

This page covers two additional forms of government intervention in microeconomics: subsidies and minimum prices.

Subsidies

Subsidies are government grants to firms that reduce production costs and encourage increased output.

Key points about subsidies:

• Aim to solve market failures and increase affordability
• Represented by shifting the supply curve downward
• Increase consumption/production of goods with positive externalities
• Can promote allocative efficiency and welfare gains

Definition: A subsidy is a money grant to firms by the government to reduce costs of production and encourage an increase in output.

The subsidy diagram shows:

1. Supply curve shifting downward (S1 to S1 + Subsidy)
2. Price decreasing (P1 to P2) and quantity increasing (Q1 to Q2)
3. Government cost represented by area P2bcd
4. Producer revenue and consumer savings illustrated

Highlight: Subsidies can solve under-consumption/production of goods with positive externalities by making marginal private cost (MPC) equal to marginal social cost (MSC).

Potential issues with subsidies include:

• Cost to government and potential need for higher taxes
• Difficulty in setting the correct subsidy level
• Possible overreliance by producers

Minimum Prices

Minimum prices are price floors set by the government above the equilibrium price.

Key points about minimum prices:

• Protect producers from price volatility and address market failures
• Result in excess supply at the minimum price
• Can lead to government intervention buying

Definition: A minimum price is a fixed price (price floor) enacted by the government, usually set above the equilibrium price.

The minimum price diagram illustrates:

1. Price increasing from P1 to Pmin
2. Quantity demanded decreasing and quantity supplied increasing
3. Excess supply between QD and QS
4. Cost of intervention buying

Highlight: Minimum prices can effectively support producers but may lead to unintended consequences such as excess supply.