subsidies (1 Viewer)

[Arithela]

after an introduction of a subsidy, what happens to the price/quantity/supply/demand of a good? thanks

 

[Jackee]

introduction of subsidy involves government providing an amount of money to aid the production process, which means more goods can be produced, which will lead to a lower price and more demand due to this lower price ( on both international and domestic markets ). it also translates to lower inflation.

 

[gnrlies]

introduction of subsidy involves government providing an amount of money to aid the production process, which means more goods can be produced, which will lead to a lower price and more demand due to this lower price ( on both international and domestic markets ). it also translates to lower inflation.

I think this post points out a rather big misconception about subsidies.

That is, that by nature they reduce prices.

This is incorrect.

The goal of a subsidy is to allow domestic producers to compete at the global price level. Indeed if you look at the standard supply and demand analysis for a subsidy it demonstrates that there is no change in price, merely a shift from international to domestic suppliers.

The reason there is not an assosciated change in price is because domestic suppliers are price takers. They cannot charge more than the world price (otherwise consumers would import these goods instead), and they can charge less than the world price but this would not be profit maximising behaviour (remembering that they can sell as much or as little as they like because at the world price they can always sell offshore).

So all that really happens, is that more domestic suppliers are willing to enter the market when given government assistance.

Now where this can get tricky is when we stop talking about homogeneous goods (commodities etc) and start talking about heterogeneous goods (cars etc). For example if the government gives subsidies to say Holden, we might say that it will lower the price because there is no obvious single "world price" for cars. You cannot directly compare a Holden to a Toyota (even if it has the same specifications and is of the same type of car). Usually subsidies do not make cars cheaper by the way they are constructed. For example subsidies given to Mitsubishi and Toyota are given for them to keep making cars in Australia (in order to protect jobs). The subsidy is essentially a payment made to these companies that covers the costs of the savings that could otherwise be made by relocating. So as you can see these cars would unlikely be cheaper if the subsidy was removed.

 

[Jackee]

I think this post points out a rather big misconception about subsidies.

That is, that by nature they reduce prices.

This is incorrect.

The goal of a subsidy is to allow domestic producers to compete at the global price level. Indeed if you look at the standard supply and demand analysis for a subsidy it demonstrates that there is no change in price, merely a shift from international to domestic suppliers.

The reason there is not an assosciated change in price is because domestic suppliers are price takers. They cannot charge more than the world price (otherwise consumers would import these goods instead), and they can charge less than the world price but this would not be profit maximising behaviour (remembering that they can sell as much or as little as they like because at the world price they can always sell offshore).

So all that really happens, is that more domestic suppliers are willing to enter the market when given government assistance.
.

I had a look back at my textbook, and the graph definately shows a drop in price. furthermore it also says "this is shown by a rightward shift of the domestic industry's supply curve from SS to S1S1 which results in a lower market price"

 

[danz90]

Well, effectively, a subsidy increases the supply of a domestic-produced good by a domestic producer.. since businesses can produce more with the financial assistance provided by the government. An increase in the supply decreases demand, which ultimately causes a contraction in price levels.

 

[Glenjamin]

You have to remember that domestic prices are higher than world prices. the introduciton of the subsidy allows domestic producers to produce(eg; investment for capital allowing for increased production), resulting in a reduction in domestic prices that allows them to be more competitive with the world market

 

[magik22]

after an introduction of a subsidy, what happens to the price/quantity/supply/demand of a good? thanks

Subsidies are provided by the government as a form of protection for domestic industries. Basically the Government pays businesses to produce a certain good and of course businesses would gladly produce the goods since they get additional funds from the Government and consumers.

The prices only go down because of the excess supply from so many businesses producing these subsidised goods and of course the quantity increases. The demand for the good would eventually lower because of 'dumping' (industries are producing so many of these goods that they eventually sell them at unrealistically low prices.)

For example, in USA they have the Export Enhancement Program (EEP) and European Union (EU) has its Common Agricultural Program (CAP). These are subsidies by these countries government for their farmers. Of course this particularly harms Australia because we are so commodities based and as a result it becomes difficult for our farmers to compete with overseas markets.

Simply put to your question. The prices do lower but not as a DIRECT result of subsidies rather he price mechanism is working its magic. Quantity obviously increases because of the subsequent dumping as does supply. The demand of the good increases in the short term because of the immense output by producers to make a buck from subsidisation. However, in the long term the demand of the good lowers because there is so much supply, the prices fall so rapidly that it hurts competitors.

I hope that helps.

 

[Arithela]

ok how do you answer this question:

Explain why the supply curve shifts from S1 to S2 (left to right) after the subsidy has been introduced. [with P1 --> P2 (price decreasing) on vertical axis, and Q1 --> Q2 (quantity increasing) on horizontal axis]

my answer: financial assistance from the government allows these producers to increase quantity(?) and reduce prices, which decreases demand (according to the graph).

somehow this doesn't make sense because why would demand decrease when prices decrease?

 

[danz90]

ok how do you answer this question:

Explain why the supply curve shifts from S1 to S2 (left to right) after the subsidy has been introduced. [with P1 --> P2 (price decreasing) on vertical axis, and Q1 --> Q2 (quantity increasing) on horizontal axis]

my answer: financial assistance from the government allows these producers to increase quantity(?) and reduce prices, which decreases demand (according to the graph).

somehow this doesn't make sense because why would demand decrease when prices decrease?

Since the supply curve shifts to the right... there is an increase in supply because the producer can produce more with the government's financial assistance, hence quantity increases. According to the law of demand and supply, as quantity/supply increases, demand decreases. Hence, there is a contraction in price, resulting in a price drop.

 

[Arithela]

thank you