Question

Question 1 Suppose the government introduces a subsidy of $5 (paid to producers) per unit into a market. a) If the government's goal is to help producers, will the subsidy be more or less effective in the short run when the demand curve is relatively elastic? (explain) (6%) b) What is the effect of the subsidy on the equilibrium price, quantity, consumer surplus, and producer surplus in the long run in a constant cost industry? (6%) c) How does the answer to c) change if the industry is increasing cost? (3%)

Answer 1

First of all we have to understand the meaning of subsidy. It is a kind of a monetary benifit given to the particular section of the society by the government. It may be to poor farmers on seeds , fertizels or procring their crops by support price etc. It can be given by the government to industries so prices of that particular commodity will substaintially reduce and avauilable to consumers at reduced rate. It will decrease the cost of production for the producers.

a. When the demand curve is more elastic that is %change in price of comoodity is less than the %change in Q.D. it means that commodity is not essential like comforts or luxuries. In the short run provision of subsidy will not be more effective as demand is elastic. May be in the long run when cost of that commodity will reduce provison of subsidy may further add to th profit for producers.

b. The role of subsidy in the long run when there is constant sot industry . Equlibrium price of that good will fall as there is provision of subsidy and definitly the portion of consumer surplus and producer surplus will rise as the industry is constant cost industry.

C. If the industry is increasing cost ,in the long run the effect of subsidy will be nullified and the portion of consumer and producer surplus will fall which will lead to increase in equlibrium price