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I think this post points out a rather big misconception about subsidies.Jackee said:introduction of subsidy involves government providing an amount of money to aid the production process, which means more goods can be produced, which will lead to a lower price and more demand due to this lower price ( on both international and domestic markets ). it also translates to lower inflation.
I had a look back at my textbook, and the graph definately shows a drop in price. furthermore it also says "this is shown by a rightward shift of the domestic industry's supply curve from SS to S1S1 which results in a lower market price"gnrlies said:I think this post points out a rather big misconception about subsidies.
That is, that by nature they reduce prices.
This is incorrect.
The goal of a subsidy is to allow domestic producers to compete at the global price level. Indeed if you look at the standard supply and demand analysis for a subsidy it demonstrates that there is no change in price, merely a shift from international to domestic suppliers.
The reason there is not an assosciated change in price is because domestic suppliers are price takers. They cannot charge more than the world price (otherwise consumers would import these goods instead), and they can charge less than the world price but this would not be profit maximising behaviour (remembering that they can sell as much or as little as they like because at the world price they can always sell offshore).
So all that really happens, is that more domestic suppliers are willing to enter the market when given government assistance.
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Subsidies are provided by the government as a form of protection for domestic industries. Basically the Government pays businesses to produce a certain good and of course businesses would gladly produce the goods since they get additional funds from the Government and consumers.Arithela said:after an introduction of a subsidy, what happens to the price/quantity/supply/demand of a good? thanks
Since the supply curve shifts to the right... there is an increase in supply because the producer can produce more with the government's financial assistance, hence quantity increases. According to the law of demand and supply, as quantity/supply increases, demand decreases. Hence, there is a contraction in price, resulting in a price drop.Arithela said:ok how do you answer this question:
Explain why the supply curve shifts from S1 to S2 (left to right) after the subsidy has been introduced. [with P1 --> P2 (price decreasing) on vertical axis, and Q1 --> Q2 (quantity increasing) on horizontal axis]
my answer: financial assistance from the government allows these producers to increase quantity(?) and reduce prices, which decreases demand (according to the graph).
somehow this doesn't make sense because why would demand decrease when prices decrease?