Effects of the Subsidy Essay Example | Topics and Well Written Essays - 1250 words

Effects of the Subsidy - Essay Example A market without a subsidy will reach equilibrium at the point where the demand curve intersects the pre-tax supply curve. Let’s assume that the price is P and the quantity is Q. The subsidy by the government will shift the supply curve downwards by the subsidy amount. The price paid by the buyers for the homes will fall from P to Ps, that is from $167,000 to $ 159,000 while the one to the suppliers will increase to Ps’ that is from $167,000 to $174,000. The quantity supplied will then increase from Q to Qs. In the graph below, the cost of the subsidy to the government is shown. The graph clearly shows a negative balance which is the cost of the subsidy which is always greater than the benefits enjoyed by the producers and the consumers. The deadweight loss of the subsidy is the amount by which the subsidy costs exceed the gains in the producer and consumer surpluses. The deadweight loss magnitude depends on the subsidy amount as well as the change in the production which results from the subsidy The benefits obtained from the subsidy are usually shared by the producers and the consumers in a proportion which depends on the relative slopes of supply and demand functions. However, the buyers gain more than the suppliers as the subsidy lowers prices to buyers and increases the price to the sellers. Assuming the two firms compete on prices à   la Bertrand with the production function and factor prices remaining the same: qM = L0.6K0.4 ;qK = L0.5 K0.5 ;the wage rate is $5 and the rental rate of capital is $10.