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:
- Supply curve shifting downward S1toS1+Subsidy
- Price decreasing P1toP2 and quantity increasing Q1toQ2
- Government cost represented by area P2bcd
- 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 pricefloor enacted by the government, usually set above the equilibrium price.
The minimum price diagram illustrates:
- Price increasing from P1 to Pmin
- Quantity demanded decreasing and quantity supplied increasing
- Excess supply between QD and QS
- Cost of intervention buying
Highlight: Minimum prices can effectively support producers but may lead to unintended consequences such as excess supply.