Why should you care about the elasticity of demand and elasticity of supply for a good...

Why should you care about the elasticity of demand and elasticity of supply for a good you are considering subsidizing? Include a demand and supply sketch in your explanation.

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Expert Solution

This is because the the share of the subsidy that goes to the buyer and the seller depends upon the elasticity of demand and elasticity of supply. We consider the demand to be highly inelastic relative to the supply it is likely that the consumer is going to benefit most from the subsidy. If the supply is highly inelastic it is likely that the producer is going to enjoy most of the subsidy. In this manner it depends upon the aim of the policy to which side of the market it is going to benefit. And it also indicates that it does not matter to whom the subsidy is provided because the ultimate share is determined by the market demand and supply elasticity

In the figure below, before subsidy price was P* and quantity was Q*. Supply is relatively inelastic. Subsidy to producers shifts the supply curve rightwards. New quantity is higher at Q1

However the price received by sellers rises to P2 while the price paid by buyers falls to P1. you can observe that the increase in the price for sellers is greater than the decrease in price for buyers. This indicates that when the supply is relatively inelastic demand produces benefit more than consumers in case of a subsidy

Rahul Sunny answered 1 year ago

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