1) Governments provide subsidies to producers and consumers to influence markets. Subsidies lower costs of production, shifting supply curves outward and lowering prices while increasing quantities traded. 2) The total spending on a subsidy equals the subsidy per unit multiplied by output. Subsidies are justified to encourage investment, protect jobs, and achieve social and political goals, but they may reduce efficiency and create dependency. 3) Cost-benefit analyses evaluate subsidies by valuing their costs and benefits, but some impacts are difficult to value and projections involve uncertainty.

1. Government Subsidies
EdExcel Economics 1.2.9

2. 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”
Apprenticeship
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

3. Basic Subsidy Diagram – For Producers
Price
Quantity / output
Supply pre
subsidy
P1
Q1
A government subsidy per unit of output paid to producers causes an
outward shift of the market supply curve leading to a lower
equilibrium price and an increase in the equilibrium quantity traded.
Demand
Supply post
subsidy
P2
Q2
Subsidy
Subsidy per unit is
shown by the
vertical distance
Exam Tip:
Don’t forget to explain the
transmission mechanism of a subsidy
through lower costs of production

4. Showing Total Government Spending on the Subsidy
Price
Quantity / output
Market
Supply pre
subsidy
P1
Q1
Total spending on the subsidy is equal to the subsidy per unit
multiplied 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

5. Justifications for Subsidies for Producers
Subsidies are a form of government intervention. They are
introduced for a number of economic, social & political 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
distribution
Reduce some of the
external costs of
transport
Encourage arts and
other cultural
services

6. Effects of Subsidies with Different Price Elasticity
Inelastic market demand
Subsidy has a larger effect on the new
equilibrium price
Price
Qty
Price
Qty
P1
Q1
Elastic market demand
Subsidy has a stronger effect on the
new equilibrium quantity
D1
P2
Q2
S1
S2
S1
S2
D1
Q1 Q2
P1
P2
Subsidy
Subsidy

7. Some Evaluation Arguments when Assessing Subsidies
• Will they achieve the desired stimulus to demand / consumption?
• Is a subsidy sufficient? Might other incentives be needed?
Are the subsidies effective in meeting their aims?
• Subsidies for investment and research can bring positive spillovers
• But firms may become dependent on state aid / financial assistance
Will a subsidy affect productivity / 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?

8. Cost Benefit Analysis
• Cost benefit analysis is a process used to measure the estimated
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 objectives for the project
2. Set project decision criteria i.e. an acceptable benefit to cost ratio
3. Identify and value the private & external costs of the project
4. Identify and value the private & external benefits of the project
5. Consider possible distributional effects e.g. on inequality
6. Discount annual value of benefits that will happen in the future
7. Adjust for various risks and uncertainties
8. Consider the unvalued / non-monetized 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

9. Evaluation: 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
• Operating 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
Uncertainties and Risks
• There are uncertainties involved
in major projects with long
construction times + operating
life that can last decades
• Forecast errors for passenger
numbers in different modes
of transport
• Uncertainties about
population growth
• Uncertainties about future
operating costs (including
energy prices)
• Future business growth /
types of businesses / impact
of new technologies
Supporters of major projects may suffer from optimism bias when evaluating a project

10. Government Subsidies
EdExcel Economics 1.2.9