Question

Consider the market for market for solar panels in Australia 2019 with an upward sloping supply curve and downward sloping demand curve. The current equilibrium price of solar panels is $250 per panel.

1. Draw a diagram showing the market for solar panel in Australia in 2019. Include and label the demand curve, supply curve, equilibrium price and quantity and the consumer and producer surplus.

b. Consider if the government introduces a subsidy to buyers of solar panels of $50 per solar panel purchased.

i. On a diagram label, the number of solar panels supplied, and solar panels demanded and the price with the price ceiling. Label the consumer and producer surplus with the subsidy.

ii. Explain who is better and worse off as a result of the subsidy. Is there a deadweight loss to this policy (assuming there are no externalities)?

Answer 1

(a)

In following graph, Price (P) and quantity (Q) are depicted vertically and horizontally. D0 and P0 are initial demand and supply curves, intersecting at point E with equilibrium price P0 (= $250) and quantity Q0.

Consumer surplus (CS) = Area between demand curve and price = Area AEP0

Producer surplus (PS) = Area between supply curve and price = Area BEP0

(b)

(i) The $50 subsidy on buyers lowers the effective price paid by buyers, so demand curve shifts rightward to D0, intersecting S0 at point F. Price received by producers increases to P1, quantity increases to Q1 and price paid by buyers decreases to P2 (where P1 - P2 = $50).

New CS = Area AGP2

New PS = Area BFP1

(ii) Since both CS and PS are higher after subsidy, both consumers and producers gain from the subsidy. But government has to pay a cost of subsidy equal to area P1FGP2, so government is worse off. There is a deadweight loss equal to area EFG.