3. 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
4. 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
5. 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
6. 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
7. 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
8. 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?
9. 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
10. 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
