Indirect  Taxes  

EdExcel  Economics  1.2.9  

Government  Subsidies  

EdExcel  Economics  1.2.9  

Government  Subsidies  for  Producers  and  Consumers  

A  subsidy  is  any  form  of  government  support—financial  or  otherwise—offered  to  producers  and  (occasionally)  consumers  

Biofuel  subsidies  for  farmers  

Solar  Panel  “Feed-­‐In  Tariffs”  

ApprenLceship  Schemes  

Aid  to  businesses  making  losses  

Subsidies  for  wind  farm  investment  

Food  /  fuel    subsidies  for  consumers  

Child  Care  for  working  families  

Subsidies  to  the  rail  industry  

Basic  Subsidy  Diagram  –  For  Producers  

Price  

QuanLty  /  output  

Supply  pre  subsidy  

P1  

Q1  

A  government  subsidy  per  unit  of  output  paid  to  producers  causes  an  outward  shiQ  of  the  market  supply  curve  leading  to  a  lower  equilibrium  price  and  an  increase  in  the  equilibrium  quanLty  traded.  

Demand  

Supply  post  subsidy  

P2  

Q2  

Subsidy  

Subsidy  per  unit  is  shown  by  the  verLcal  distance  

Exam  Tip:    Don’t  forget  to  explain  the  transmission  mechanism  of  a  subsidy  through  lower  costs  of  producLon  

Showing  Total  Government  Spending  on  the  Subsidy  Price  

QuanLty  /  output  

Market  Supply  pre  subsidy  

P1  

Q1  

Total  spending  on  the  subsidy  is  equal  to  the  subsidy  per  unit  mulLplied  by  the  level  of  output  –  shown  by  the  shaded  area  

Market  Demand  

Market  Supply  post  subsidy  

P2  

Q2  

P3  

Producer  receives  this  price  

Consumer  pays  this  price  

JusEficaEons  for  Subsidies  for  Producers  

Subsidies  are  a  form  of  government  intervenLon.  They  are  introduced  for  a  number  of  economic,  social  &  poliEcal  reasons  

Help  poorer  families  e.g.  food  and  child  

care  costs  

Encourage  output  and  investment  in  fledgling  sectors  

Protect  jobs  in  loss-­‐making  industries  e.g.  hit  by  recession  

Make  some  health  care  treatments  more  affordable  

Reduce  the  cost  of  training  &  employing  

workers  

Achieve  a  more  equitable  income  

distribuLon  

Reduce  some  of  the  external  costs  of  

transport  

Encourage  arts  and  other  cultural  

services  

Effects  of  Subsidies  with  Different  Price  ElasEcity  

InelasEc  market  demand  Subsidy  has  a  larger  effect  on  the  new  

equilibrium  price  

Price  

Qty  

Price  

Qty  

P1  

Q1  

ElasEc  market  demand  Subsidy  has  a  stronger  effect  on  the  

new  equilibrium  quanLty  

D1  

P2  

Q2  

S1  

S2  

S1  

S2  D1  

Q1   Q2  

P1  P2  

Subsidy  Subsidy  

Some  EvaluaEon  Arguments  when  Assessing  Subsidies  

• Will  they  achieve  the  desired  sLmulus  to  demand  /  consumpLon?  •  Is  a  subsidy  sufficient?  Might  other  incenLves  be  needed?  

Are  the  subsidies  effecLve  in  meeLng  their  aims?  

•  Subsidies  for  investment  and  research  can  bring  posiLve  spillovers  •  But  firms  may  become  dependent  on  state  aid  /  financial  assistance  

Will  a  subsidy  affect  producLvity  /  efficiency?  

•  Is  a  subsidy  part  self-­‐financing?  Will  it  create  more  tax  revenue?  •  Or  does  a  subsidy  create  an  expensive  extra  burden  for  taxpayers?  

How  much  does  the  subsidy  cost  and  who  benefits?  

•  For  example  –  do  more  people  find  work  with  child  care  subsidies?  •  Or  does  a  subsidy  lead  to  undesired  /  unintended  consequences?  

Does  the  subsidy  help  to  correct  a  market  failure?  

Cost  Benefit  Analysis  

•  Cost  benefit  analysis  is  a  process  used  to  measure  the  esLmated  net  social  rate  of  return  from  an  investment  project.  

•  When  governments  are  deciding  how  much  to  spend  on  public  goods,  they  might  use  a  cost-­‐benefit  approach  to  aid  them  

•  A  typical  cost  benefit  analysis  involved  the  following  process:  1.  Set  the  key  objecEves  for  the  project  2.  Set  project  decision  criteria  i.e.  an  acceptable  benefit  to  cost  raEo  3.  IdenLfy  and  value  the  private  &  external  costs  of  the  project  4.  IdenLfy  and  value  the  private  &  external  benefits  of  the  project  5.  Consider  possible  distribuEonal  effects  e.g.  on  inequality  6.   Discount  annual  value  of  benefits  that  will  happen  in  the  future  7.  Adjust  for  various  risks  and  uncertainEes    8.  Consider  the  unvalued  /  non-­‐moneEzed  costs  and  benefits  9.  Measure  the  expected  net  social  return  from  the  project  10.  Compare  with  expected  net  social  returns  from  other  projects  i.e.  

the  opportunity  cost  of  £billion  invested  in  a  project    

EvaluaEon:  Problems  with  Cost  Benefit  Analysis  

Assigning  monetary  values  •  Some  aspects  of  a  project  can  be  

assigned  a  monetary  value  •  Time  savings  e.g.  For  

passengers  and  businesses  •  OperaLng  costs  of  the  project  •  Value  of  carbon  emissions  e.g.  

Lower  CO2  from  less  car  use  •  Risk  of  death  or  injury  

•  Other  variables  are  much  harder  to  assign  values  •  Bio-­‐diversity  •  Water  quality  •  Air  quality  •  Heritage    •  Social  inclusion  /  accessibility  

UncertainEes  and  Risks  •  There  are  uncertainLes  involved  

in  major  projects  with  long  construcLon  Lmes  +  operaLng  life  that  can  last  decades  •  Forecast  errors  for  passenger  

numbers  in  different  modes  of  transport    

•  UncertainLes  about  populaLon  growth  

•  UncertainLes  about  future  operaLng  costs  (including  energy  prices)  

•  Future  business  growth  /  types  of  businesses  /  impact  of  new  technologies  

Supporters  of  major  projects  may  suffer  from  opLmism  bias  when  evaluaLng  a  project  

Government  Subsidies  

EdExcel  Economics  1.2.9