A subsidy is a payment made to firms or consumers designed to encourage an increase in output. A subsidy will shift the supply curve to the right and therefore lower the equilibrium price in a market. Show The aim of the subsidy is to encourage production of the good and it has the effect of shifting the supply curve to the right (shifting it vertically downwards by the amount of the subsidy). This is shown in Figure 1 below.  Figure 1 Impact of a subsidy The amount of the subsidy is shown by the gap between the supply curves. This subsidy will cost the government money and we can use the diagram to show the amount they have to spend. Total subsidy expenditure will be the subsidy per unit (the vertical gap between the supply curves) multiplied by the number of units that are traded on the market. This gives the area shown in Figure 2 below. Figure 2 Subsidy expenditure As with a tax (see the previous section - click on the left arrow at the top or bottom of the page), some of the subsidy will benefit the consumer (the amount of the price decrease) and some will benefit the firm. This effect can be seen in Figure 3 below. Figure 3 Subsidy shares - producer and consumer How do subsidies affect prices?When government subsidies are implemented to the supplier, an industry is able to allow its producers to produce more goods and services. This increases the overall supply of that good or service, which increases the quantity demanded of that good or service and lowers the overall price of the good or service.
What happens when the price of a good increases the quantity of goods that are produced increases?The law of supply is the microeconomic law that states that, all other factors being equal, as the price of a good or service increases, the quantity of goods or services that suppliers offer will increase, and vice versa.
What would the impact be in a market where there are subsidies granted to producers?Giving subsidies to farmers can support higher produce prices, but remove any incentives for farmers to become more efficient.
How does subsidy affect supply?A subsidy increases supply because it increases the producers' received revenue to lower the cost of producing goods and encourage production. Governments are using subsides to increase production.
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What happens to the price of a good and the quantity of a good produced when that good is subsidized?
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