Subsidy (AS/A LEVELS/IB/IAL)

Level: AS Levels, A Level, GCSE – Exam Boards: Edexcel, AQA, OCR, WJEC, IB, Eduqas – Economics Revision Notes 

Subsidy

What is the definition of a ‘Subsidy’?

A subsidy is a grant provided by the government which decreases the cost of production and increases output.

Governments provide subsidies for merit goods which are benefits to society. For example the UK government is currently providing subsidies towards the purchase of electric cars.

The impact of Subsidies on consumers, producers, and the Government

Consumers

• Increase Output and Lower Prices – subsidies are grants given to firms to help them cover some of their costs. This can lead to greater amounts of output being produced and lower prices for consumers
• Reduced Inequality – if the subsidy is progressive, it can help to reduce income inequality
• Positive Externalities – subsidies can increase the consumption of merit goods, creating positive externalities

Producers

• Lower Costs – subsidies can increase the employment rate by enhancing the skillsets of workers and reducing the cost of employing them
• Lower Production Costs – production costs may fall as subsidies can help to control inflation
• Long Run Aggregate Supply can increase – if the subsidy is used towards a capital project, it is likely the Long Run Aggregate Supply will increase

Government

• Government Failure – government failure may arise if the subsidy distorts the market price of the subsidy granted is ineffective
• Opportunity Cost – there is an opportunity cost which needs to be considered – could the government revenue be spent more effectively elsewhere?
• Equilibrium Price – the subsidy will have a larger impact on equilibrium price if the demand is price inelastic, providing consumers with greater consumer gain

Quick Fire Quiz – Knowledge Check

1. Define ‘subsidy’ (2 marks)

2. Draw a diagram showing the subsidy areas (4 marks)

• Consumer subsidy
• Producer subsidy

3. Explain the impact of Subsidies on Consumers (4 marks)

4. Explain the impact of Subsidies on Producers (4 marks)

5. Explain the impact of Subsidies on the Government (4 marks)

Next Revision Topics:

• Government Intervention
• Merit & Demerit Goods
• Externalities
• Maximum Prices (Price Ceilings)
• Consumer & Producer Surplus

A Level Economics Past Papers

• AQA
• Edexcel
• OCR
• WJEC