Question

Consider a representative firm operating in the perfectly competitive market for

apples. Suppose the Government applies a per unit subsidy on the goods sold

(all else unchanged). In the long run, the number of firms in the market will remain the

same, but each firm will increase its production.

Answer 1

A perfectly competitive market is a market structure in which there are many buyers and producers in a market selling similar goods and every agent in the market have perfect knowledge of the market and they are also free to enter or exit from the market.

Subsidy is a financial help from the government, generally provided for the production of merit goods to encourage its consumption by bringing the price at a lower rate.

If a firm is operating in a perfectly competitive market for apples, and if government applies a per unit subsidy on the goods sold ( all other things remaining the same). This per unit subsidy on apples decreases the cost of producing apples and hence the firm can produce more apples now than what it used to produce before. This can be seen through the following diagram -

It can be seen in the graph that, with the provision of subsidy and decrease in cost of production, there is increase in supply of apples from S to S1, which leads to a decrease in price from P to P1 and hence the quantity consumed of apples increases from Q to Q1. Since there is decrease in price so normally new firms will not be attracted towards this industry, but since the cost has decreased so each firm in the industry produces a greater output.