A quantity subsidy is a subsidy per unit sold of a given good. The subsidy is...

A quantity subsidy is a subsidy per unit sold of a given good. The subsidy is paid by the government and can be given either to the consumers or the producers.

(a) What is the relationship between the price buyers pay and the price sellers receive when the subsidy equals s? What is the condition for equilibrium in this market? Does it matter whom the subsidy is given to?

(b) Suppose that the subsidy is given to the producers. How will the supply curve shift? Draw a carefully labeled diagram showing the new equilibrium - the price for the buyers, the price for the sellers, and the equilibrium quantity sold q^s.

(c) Suppose that the subsidy is given to the buyers. How will the demand curve shift? Draw a carefully labeled diagram showing the new equilibrium - the price for the buyers, the price for the sellers, and the equilibrium quantity sold q^s.

(d) What determines who benefits more from the subsidy? (Hint: one way to measure the relative benefit from the subsidy is by the ratio (p^∗−p_b)/(p_s−p^∗).

(e) Add to your diagram the consumer and producer surplus before and after the subsidy. Show the cost to the government resulting from the subsidy in the new equilibrium.

(f) Show the deadweight loss. Explain why the deadweight loss occurs. (Hint: relate your answer to the rise of inefficient transactions caused by the subsidy).

Solutions

Expert Solution

a) The relationship between buyer's price and seller's price is :

Buyer's price + Subsidy = Seller's price

Condition for equilibrium in this market is Demand = Supply.

Here, the equilibrium price is P and the equilibrium quantity is Q.

Yes. it matters whom the subsidy is given as explained in b and c below.

b) When subsidy is given to the sellers, supply curves shifts to the right to S' as shown in the diagram below. As a result equilibrium quantity increases to Q_S. Price for sellers is denoted by P_S whereas, price for buyers is denoted by P_B.

c) When subsidy is given to buyers , the demand curve shifts to the right to D' as shown in the diagram below. As a result equilibrium quantity increases to Q_S. Here, the price for buyers is denoted by P_B and the price for sellers is denoted by P_S.

d) To determine the benefits of subsidy to the sellers and buyer we calculate the ratio of (P-P_B)/(P_S-P).

If the ratio is greater than 1 , buyers are benefited more.

If the ratio is less than 1, sellers are benefited more.

Rahul Sunny answered 1 year ago

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