Answer to Question #281108 in Microeconomics for Ali Mammadov

Question

Suppose the government pays $10 subsidy per tonne of wheat produced. Show how the subsidy affects consumer surplus, producer surplus, government revenue/expenditure and total surplus. Does the subsidy cause deadweight loss?

Answer 1

A subsidy generally affects the market by decreasing the price paid by buyers and raising the quantity that is sold. Because it costs more than whatever benefits it delivers, the subsidy is pareto inefficient. This is illustrated by the figure below:

The effect of subsidy is that the sellers will then charge Z less than they are willing to accept because the difference will be made up by the government.

Sellers gain area A in new producer surplus while buyers who then pay a lower price, gain area B in consumer surplus.

The total cost of the subsidy to the government is $Z*Q_n$ which is A+B+C. The subsidy hence costs C dollars more than yhe benefits that it delivers. Area C is the dead weight loss.