Cambridge International as and a level Economics Ebook

Subsidies
Another form of government intervention in the market 
is through the provision of subsidies. Th
ese are direct 
payments made by governments to the producers of goods 
and services. When paid to a producer, a subsidy has the 
opposite eff ect of an indirect tax – it is the equivalent of a 
fall in costs for the producer and results in a rightward shift
in the market supply curve. Th
is is shown in 
Figure 3.7
. 
A reduction in a subsidy payment will lead to a shift to the 
left in the supply curve.
Figure 3.7
 shows that introducing a subsidy in the 
market results in a fall in price from 
P
to 
P
1
and an 
increase in the quantity traded from 
Q
to 
Q
1
. Th
is is the 
usual eff ect on the market when governments pay money 
to producers and may be done for many reasons including:
■
to keep down the market prices of essential goods
■
to encourage greater consumption of merit goods
■
to contribute to a more equitable distribution of income
■
to provide services that would not be provided by the 
free market
■
to raise producers’ income, especially in the case of farmers
■
to provide an opportunity for exporters to sell more goods
■
to reduce dependence on imports by paying subsidies to 
domestic producers of close substitutes.
Allocating subsidies from limited government revenue 
is a controversial issue. It is not only interfering with the 
workings of the market mechanism but has opportunity 
cost implications. Another problem is that subsidies are 
so-called ‘blanket’ or lump sum payments and, unlike 
taxes on consumers, cannot easily be linked to incomes 
and the ability to pay. It is therefore necessary to assess 
who benefi ts from a particular subsidy. Th
is is illustrated 
by the following examples:
■
Staple foods like rice, bread and cooking oil are subsidised in 
some developing economies. As world food prices continue 
to rise, the case for subsidy is a strong one, mainly to provide 
relief for the poorest groups in the economy. Subsidised 
prices, however, are paid by all income groups, many of who 
can aff ord to pay more. There could also be shortages as in 
the case of a price ceiling. If the subsidy is paid to producers, 
there is no incentive for ineff icient producers to improve.
■
Mass transit (public transport) is heavily subsidised in all