Producer and Consumer Subsidies

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A revision presentation on the economics of producer and consumer subsidies as forms of government intervention in markets. There are a number of up to date examples highlighted together with an evaluation of the benefits and costs of subsidy payments. This is designed as a revision aid for unit 1 students taking their microeconomics papers.

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Producer and Consumer Subsidies

  1. 1. Producer and Consumer Subsidies AS Micro Revision November 2013
  2. 2. Producer Subsidies • A subsidy is a payment by the government to suppliers that reduce their costs of production and encourages them to increase output • State subsidises are financed from general taxation or by borrowing • The subsidy causes the firm's supply curve to shift to the right • The amount spent on the subsidy is equal to the subsidy per unit multiplied by total output
  3. 3. Producer Subsidies • A subsidy is a payment by the government to suppliers that reduce their costs of production and encourages them to increase output • State subsidises are financed from general taxation or by borrowing • The subsidy causes the firm's supply curve to shift to the right • The amount spent on the subsidy is equal to the subsidy per unit multiplied by total output
  4. 4. Producer Subsidies • A subsidy is a payment by the government to suppliers that reduce their costs of production and encourages them to increase output • State subsidises are financed from general taxation or by borrowing • The subsidy causes the firm's supply curve to shift to the right • The amount spent on the subsidy is equal to the subsidy per unit multiplied by total output
  5. 5. Producer Subsidies • A subsidy is a payment by the government to suppliers that reduce their costs of production and encourages them to increase output • State subsidises are financed from general taxation or by borrowing • The subsidy causes the firm's supply curve to shift to the right • The amount spent on the subsidy is equal to the subsidy per unit multiplied by total output
  6. 6. Examples of subsidies • A payment on the factor cost of a product – e.g. a guaranteed minimum price offered to farmers such as under the old-style Common Agricultural Policy (CAP). • An input subsidy which subsidises the cost of inputs used in production – e.g. an employment subsidy • Government grants to cover losses made by a business – e.g. a grant given to cover losses in the rail industry or a loss-making airline • Bail-outs e.g. for financial organisations in the wake of the credit crunch • Financial assistance (loans and grants) for businesses setting up in areas of high unemployment
  7. 7. Examples of subsidies • A payment on the factor cost of a product – e.g. a guaranteed minimum price offered to farmers such as under the old-style Common Agricultural Policy (CAP). • An input subsidy which subsidises the cost of inputs used in production – e.g. an employment subsidy • Government grants to cover losses made by a business – e.g. a grant given to cover losses in the rail industry or a loss-making airline • Bail-outs e.g. for financial organisations in the wake of the credit crunch • Financial assistance (loans and grants) for businesses setting up in areas of high unemployment
  8. 8. Examples of subsidies • A payment on the factor cost of a product – e.g. a guaranteed minimum price offered to farmers such as under the old-style Common Agricultural Policy (CAP). • An input subsidy which subsidises the cost of inputs used in production – e.g. an employment subsidy • Government grants to cover losses made by a business – e.g. a grant given to cover losses in the rail industry or a loss-making airline • Bail-outs e.g. for financial organisations in the wake of the credit crunch • Financial assistance (loans and grants) for businesses setting up in areas of high unemployment
  9. 9. Examples of subsidies • A payment on the factor cost of a product – e.g. a guaranteed minimum price offered to farmers such as under the old-style Common Agricultural Policy (CAP). • An input subsidy which subsidises the cost of inputs used in production – e.g. an employment subsidy • Government grants to cover losses made by a business – e.g. a grant given to cover losses in the rail industry or a loss-making airline • Bail-outs e.g. for financial organisations in the wake of the credit crunch • Financial assistance (loans and grants) for businesses setting up in areas of high unemployment
  10. 10. Examples of subsidies • A payment on the factor cost of a product – e.g. a guaranteed minimum price offered to farmers such as under the old-style Common Agricultural Policy (CAP). • An input subsidy which subsidises the cost of inputs used in production – e.g. an employment subsidy • Government grants to cover losses made by a business – e.g. a grant given to cover losses in the rail industry or a loss-making airline • Bail-outs e.g. for financial organisations in the wake of the credit crunch • Financial assistance (loans and grants) for businesses setting up in areas of high unemployment
  11. 11. Diagrams matter! Diagram must haves Fully labeled Original and new equilibrium Demand and supply the correct way round Well explained – you must explain why the curve has shifted, in detail Think about the elasticity – e.g. oil has inelastic demand and supply
  12. 12. Analysing the effects of a subsidy Costs and Benefits Supply pre subsidy A Supply post subsidy Demand B Output
  13. 13. Analysing the effects of a subsidy Costs and Benefits Supply pre subsidy A Supply post subsidy C Demand B D Output
  14. 14. Analysing the effects of a subsidy Costs and Benefits Supplier E receives C Supply pre subsidy A Supply post subsidy Consumer C pays B Demand B D Output
  15. 15. Analysing the effects of a subsidy Costs and Benefits Supplier E receives C Supply pre subsidy A Supply post subsidy Consumer C pays B Subsidy payment Demand B D Output
  16. 16. Consumer and producer surplus Price Market price and quantity before the subsidy is P1 and Q1 S1 pre subsidy S2 post subsidy P1 Demand Q1 Output
  17. 17. Consumer and producer surplus Price Consumer surplus is area ABP1 S1 pre subsidy A P1 B S2 post subsidy Demand Q1 Output
  18. 18. Consumer and producer surplus Price Producer surplus = area P1BC S1 pre subsidy A P1 B C S2 post subsidy Demand Q1 Output
  19. 19. Consumer and producer surplus Price The subsidy causes a fall in market price to P2 S1 pre subsidy A P1 B S2 post subsidy P2 C Demand Q1 Q2 Output
  20. 20. Consumer and producer surplus Price Consumer surplus increases to area ADP2 S1 pre subsidy A P1 B S2 post subsidy D P2 C Demand Q1 Q2 Output
  21. 21. Consumer and producer surplus Price Producer surplus boosted through the subsidy payment S1 pre subsidy A P3 P1 E B S2 post subsidy D P2 C Demand Q1 Q2 Output
  22. 22. Arguments for Subsidies Controlling price inflation e.g. food prices Boost employment especially in poor areas Improve human capital and productivity Protect strategic / infant industries Promote growing demand for renewables Improve affordability for low-income families
  23. 23. Arguments for Subsidies Controlling price inflation e.g. food prices Boost employment especially in poor areas Improve human capital and productivity Protect strategic / infant industries Promote growing demand for renewables Improve affordability for low-income families
  24. 24. Arguments for Subsidies Controlling price inflation e.g. food prices Boost employment especially in poor areas Improve human capital and productivity Protect strategic / infant industries Promote growing demand for renewables Improve affordability for low-income families
  25. 25. Arguments for Subsidies Controlling price inflation e.g. food prices Boost employment especially in poor areas Improve human capital and productivity Protect strategic / infant industries Promote growing demand for renewables Improve affordability for low-income families
  26. 26. Arguments for Subsidies Controlling price inflation e.g. food prices Boost employment especially in poor areas Improve human capital and productivity Protect strategic / infant industries Promote growing demand for renewables Improve affordability for low-income families
  27. 27. Arguments for Subsidies Controlling price inflation e.g. food prices Boost employment especially in poor areas Improve human capital and productivity Protect strategic / infant industries Promote growing demand for renewables Improve affordability for low-income families
  28. 28. India and Food Subsidies India is introducing a policy aimed at providing subsidised food to two thirds of the population. The new food security law will provide five kilos of cheap grain every month to nearly 800 million Indians. Can a new food law solve as long-running problem or will it drain the country's finances? The government says that money is not a problem.
  29. 29. Thailand and Rubber Subsidies Thailand has doubled subsidies to rubber farmers. The Thai cabinet on Tuesday approved the assistance of 21.2bn baht ($659m) to rubber smallholders, after a dispute that has led to shipment delays and to scuffles between police and farmers demonstrating in the south. Thailand is a leading world exporter of both rubber and rice, but has faced problems managing both industries as state financial support programmes have led to the build-up of stockpiles. The Thai government’s expanding commodity subsidy programme is in part an effort to bolster the income of farmers at a time of falling world prices. Natural rubber prices have almost halved since the peak of February 2011 Source: News reports, October 2013
  30. 30. Is there a case for a NEET subsidy? • The number of young people not in education, employment or training in the UK was 1.07m people aged 16 to 24 in the 3rd quarter of 2013 • Youth Contract launched in 2011 – it offers internships, work experience and subsidies for businesses to take on new employees. • But few companies are taking up the offer of wage subsidies. In the first year of the scheme – designed to fund jobs for 160,000 people over three years – it was used to employ fewer than 5,000 young people Source: News reports, Oct 2013
  31. 31. Child care subsidies – a way forward? Britain ranks 15th out of 25 OECD nations for maternal employment, languishing behind Germany, France, Canada and the USA In New Zealand – the government offers subsidies for inhome nanny services. The childcare rebate (subsidy) currently provides parents with 50% of their childcare costs up to a total of $7,500 a year for each child. With the UK childcare voucher scheme, an average family with two working parents claiming vouchers can save up to £1,866 a year towards their childcare costs if both parents buy vouchers but only if their employer has signed up to a scheme
  32. 32. End to UK biomass subsidy
  33. 33. Biomass subsidies have increased demand for wood, pushing prices higher Price of Timber S1 P2 P1 D2 D1 Q1 Q2 Quantity of Timber
  34. 34. Evaluation – Criticism of Subsidies Distortion of market prices / incentives Risk of fraud from subsidy payments Expensive – high cost for taxpayers Inequitable – many rich people may benefit Environmental damage Protects inefficient businesses
  35. 35. Evaluation – Criticism of Subsidies Distortion of market prices / incentives Risk of fraud from subsidy payments Expensive – high cost for taxpayers Inequitable – many rich people may benefit Environmental damage Protects inefficient businesses
  36. 36. Evaluation – Criticism of Subsidies Distortion of market prices / incentives Risk of fraud from subsidy payments Expensive – high cost for taxpayers Inequitable – many rich people may benefit Environmental damage Protects inefficient businesses
  37. 37. Evaluation – Criticism of Subsidies Distortion of market prices / incentives Risk of fraud from subsidy payments Expensive – high cost for taxpayers Inequitable – many rich people may benefit Environmental damage Protects inefficient businesses
  38. 38. Evaluation – Criticism of Subsidies Distortion of market prices / incentives Risk of fraud from subsidy payments Expensive – high cost for taxpayers Inequitable – many rich people may benefit Environmental damage Protects inefficient businesses
  39. 39. Evaluation – Criticism of Subsidies Distortion of market prices / incentives Risk of fraud from subsidy payments Expensive – high cost for taxpayers Inequitable – many rich people may benefit Environmental damage Protects inefficient businesses
  40. 40. Do subsidies hold back innovation?
  41. 41. Surpluses can lead to excess capacity and long term damage – the EU fishing industry is an example
  42. 42. Short term and long term effects “In general, subsidies should be employed to change behaviour and solve specific problems rather than to serve as a long-term crutch for producers. If not, it will stifle innovation and make producers both less competitive and more dependent on government.” Source: Jason Clay, Guardian, August 2013
  43. 43. Renewable Energy & Solar Subsidies
  44. 44. Consumer Subsidies: Feed-In-Tariffs
  45. 45. Using cross-elasticity of demand, assess the likely relationship between the demand for solar panels and the price of household electricity from non-renewable sources
  46. 46. Rising electricity prices Incentives to switch to renewable energy There is a cost to switching Rising market demand for solar panels
  47. 47. Despite a strong rise in demand, the market price of solar panels has fallen in recent years. With the help of a supply and demand diagram, explain why this can have happened Price of solar panels S1 P1 D1 Q1 Quantity
  48. 48. Despite a strong rise in demand, the market price of solar panels has fallen in recent years. With the help of a supply and demand diagram, explain why this can have happened Price of solar panels S1 P1 D1 D1 Q1 Quantity
  49. 49. Despite a strong rise in demand, the market price of solar panels has fallen in recent years. With the help of a supply and demand diagram, explain why this can have happened Price of solar panels S1 P2 P1 D2 D1 Q1 Quantity
  50. 50. Despite a strong rise in demand, the market price of solar panels has fallen in recent years. With the help of a supply and demand diagram, explain why this can have happened Price of solar panels S1 P2 P1 S2 D2 D1 Q1 Quantity
  51. 51. Despite a strong rise in demand, the market price of solar panels has fallen in recent years. With the help of a supply and demand diagram, explain why this can have happened Price of solar panels S1 P2 P1 S2 P3 D2 D1 Q1 Quantity
  52. 52. Despite a strong rise in demand, the market price of solar panels has fallen in recent years. With the help of a supply and demand diagram, explain why this can have happened Price of solar panels S1 P2 P1 S2 P3 D2 D1 Q1 Q2
  53. 53. Evaluate the argument for government intervention in the market for solar panels to encourage the growth of renewable energy rather than allowing free market forces to operate
  54. 54. The case for solar subsidies Promotes renewable energy and lowers oil dependency Creates thousands of new jobs – + a positive multiplier effect Cuts bills for consumers & councils Economies of scale if the take-up of panels increases
  55. 55. Solar subsidies – critical evaluation Subsidies benefit richer households Limited effectiveness for money spent – opportunity cost Mis-selling of solar panels especially to vulnerable households Most solar panels are imported
  56. 56. Get help from fellow students, teachers and tutor2u on Twitter: #econ1 @tutor2u @tutor2u-econ

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