EFFECT OF A SUBSIDY

If the government subsidises a product this means that the supply curve will shift out to
the right and both consumer and producer surpluses will increase.

However to achieve this increase in both consumer and producer surpluses, the government
has had to pay more in the form of a subsidy than society has received in extra benefits
(consumer and producer surpluses). This will lead to a loss in total welfare to society
(deadweight loss).

Use the image below to see the effects of a subsidy.
Place the mouse on each of the catergories to see the area highlighted on the graph.

Amount of subsidy is $8.00 per unit. Total Government spending on subsidy is equal to the area putline by the pink rectangle. $8.00 x 30 000 = $240 000. Deadweight Loss caused by the subsidy is equal to the area in green = $8.00 x 1/2 10 000 = $40 000 The new producer surplus is the area in Grey. $8.00 x 1/2 30 000 = $120 000. The producer now receives $30 + $8 subsidy so $38 per unit. Point Pp on the graph.