Question

6. Consider the following $10 subsidy for producers. Figure 3: A Per-Unit Subsidy of $10 SUPPLY SUPPLY (W 30 40 (a) What is the Producer Surplus under the subsidy? (5%) (b) What is the subsidy's Deadweight Loss? (5%) (c) What would the Total Surplus be under a free market? (5%)

Answer 1

6a)The money given by the government to the firms to encourage production is called subsidy.The effe t of a $10 subsidy is to shift the supply curve downwards by the amount of the subsidy .This will reduce price and increase quantity.But the price will not fall by the same amount of subsidy and the producer gets some benefitby way of extra money .In the diagram with $10 subsidy , the new price falls from the equilibrium price 40 to 35 and quantity increases from 30 to 40.The per unit gain to the consumer is 40(equilibrium price) - 35 (new price with subsidy)=5 The total consumers surplus is shown by the shaded area.The per unit gain to the producer is 45( the  priceabove the equilibrium price)-40 (equilibrium price)=5. The total producer's surplus is shown by the shaded area.

b) The dead weight loss is the shaded area c shown in the diagram. The dead weight loss is the reduction in producers and consumers surplus. Dead weight loss is .5*(P2-P1)*(Q1-Q2)=.5*(45-35)*(30-40)=.5*-10*-10=50

c)Total surplus is consumers surplus +producers surplus.It is total area of producers surplus plus totak area of consumers surplus.