Question

 This chapter analyzed the welfare effects of a tax on a good. Consider now the opposite policy. Suppose that the government subsidizes a good. For each unit of the good sold, the government pays $2 to the buyer.

 Use the black point (plus symbol) to indicate the initial equilibrium in this market before the subsidy. Then use the green point (triangle symbol) to shade the area representing consumer surplus, and use the purple point (diamond symbol) to shade the area representing producer surplus.

 On the following graph, use the tan segment (dash symbols) to indicate the wedge formed between the price received by producers and the price consumers pay out of their own pocket. (Hint: Find the quantity to the right of the initial equilibrium where the difference between the supply and demand curves is $2.) Next use the black point (plus symbol) to indicate the price producers receive at that quantity, and use the grey point (star symbol) to indicate the price consumers pay not including the subsidy. Then use the green triangle (triangle symbols) to indicate consumer surplus the presence of this subsidy, and the purple triangle (diamond symbols) to indicate producer surplus.

Answer 1

A subsidy is a financial aid given to either for the producer or the consumers, if the subsidy is given to the producer that will decrease the business cost of the firm so the firm has an incentive to produce more at low cost. A subsidy lowers the business cost and increase the production, so the supply curve shifts right. The per unit subsidy is equal to the vertical distance between the new and the old supply curve.

The consumer surplus is the area below the demand curve and above the price line, the producer surplus is the area above the supply curve and below the price line.

The subsidy increases the price sellers receive and decreases the price that buyers pay.