Subsidies to Correct Market Failure content slideshow. Designed for the Economic A level qualification. Can be used in revision and in class. Subtopics Recap and Analysis of Subsidies Pros and Cons of Subsidies

1. Subsidies to
Correct
Market Failure
Lower 6th Micro
Government Intervention

2. Recap and
Analysis of
Subsidies
Subsidies to Correct Market Failure
Mr O’Grady

3. Subsidies to Correct Market Failure
Subsidies (recap): Government support, usually financial, to suppliers that cover
some of their costs.
They increase the supply of the good by artificially reducing the firm’s cost of production
Analysis: Subsidies artificially lower the costs of production, leading to a lower
market price and higher quantity traded
They are a vital tool to correct market failures which lead to under-consumption/production
Used to correct positive externalities
Quantity
Price
S
S + Sub

4. Correcting Positive Consumption Externalities:
In a free market, QFM is consumed (MPB = MPC), but the
socially optimal quantity is higher at QSO (MSB = MSC)
The implementation of the subsidy artificially decreases
the costs of production, shifting supply/MPC outwards
A new equilibrium occurs with QSO demanded at price PS
MPB = MPC + Sub
Total welfare improves by raising quantity (green triangle)
Correcting Positive Production Externalities:
In a free market, QFM is consumed (MPB = MPC), but the
socially optimal quantity is higher at QSO (MSB = MSC)
The implementation of the subsidy artificially decreases
the costs of production, shifting supply/MPC outwards
A new equilibrium occurs with QSO demanded at price PS
equal to PSO
MPB = MPC + Sub
Total welfare improves by raising quantity (green triangle)
Price
Quantity
D = MPB
QSO
S = MPC
= MSC
D1 = MSB
PFM
PSO
QFM
S + Sub =
MPC + Sub
PS
Price
Quantity
D = MPB
= MSB
QSO
S1 = MSC
PFM
PSO
QFM
S = MPC
S + Sub =
MPC + Sub
=PS

5. Pros and Cons
of Subsidies
Subsidies to Correct Market Failure
Mr O’Grady

6. Pros and Cons of Subsidies
Pros:
Precise and targeted: external benefits are internalised, so the market provides more of the
beneficial product
Alternative Products still available: The markets for alternatives are not totally distorted and
consumer choice is preserved (private education for example)
Controls inflation: the subsidy pushes prices down
Cons:
Demand may be inelastic: the increase in output may be insignificant, the socially optimum
point may not be achieved
Opportunity cost of subsidies: Higher taxes/public spending cuts elsewhere required to fund
subsidy
Difficult to set a monetary value of the externality: Hard to get the size of the subsidy right-
it’s value to society is subjective
Gov Policy: Temptation to remove subsidies in difficult times exists

7. Where next?
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