# Microeconomics.Consumer subsidy

1. Mar 18, 2010

### Tre75v

Hi all, hope this is in the right spot.I have just started undergrad studies and I have an essay question asking how an industry will react to a consumer subsidy.Our text books don't cover it, and the lecturer won't answer question, and google has failed me.
I am seeing the supply curve shifts to the right, I cannot work what to do about equilibrium price.
I have P2Q2 marking the new quantity demanded to show the subsidy amount.
I am in serious trouble here, can anyone point me in the right direction please.
View attachment Graph.doc

2. Mar 18, 2010

### Matterwave

So, if you subsidize consumers, then in effect at every price P, they only "see" a price P-S where S is the subsidy (assuming a per-unit subsidy).

So, let's just say the price is $10 and the subsidy is$5. The consumer then only sees the price as $5 and will buy however many he demanded at$5. This is shown through a shifting out of the demand curve. This means, that, in general (if we assume downward sloping demand), the consumer demands more at a given price P. The seller can then maximize profits to reflect such an increased demand. The general rule is then higher sales and higher prices.

The supply curve shouldn't shift since the subsidy is applied to consumers.

So you have the same supply curve, and a shifted demand curve. The new intersection of which is the equilibrium.

3. Mar 19, 2010

### Tre75v

I battled this one for 4 days, I was thrown off by youtube lectures talking about a subsidy to producers.
Correct me if I'm wrong, but demand curve shifts right and up by the amount of the subsidy.
The supply curve will remain where it is , but the cost of producing additional units will increase the price to a new equilibrium point at the intersection of Supply curve and New demand curve.
I appreciate your help heaps Matterwave.

4. Mar 19, 2010

### imiyakawa

Matterwave basically answered your question. It is up to you to extrapolate consequences of what he said to industry.

BUT, I think there might actually be a shift in the supply curve as well as the demand curve if you consider what you said: the law of diminishing returns. As the consumer subsidy increases, demand increases, and at some point the cost/unit of production increases (law of diminishing returns). THIS WOULD CAUSE A SHIFT IN THE SUPPLY CURVE, as producers are less inclined to supply. So there would be two competing elements. Of course, consumer demand (shift in D-curve) would outweight increased costs per unit (shift in S-curve) by a huge margin, but the process is there.

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ALSO, the question asked the consequences of this subsidy to industry. You should talk about how perhaps, if it was an oligopolistic industry, new players would flood into the industry resulting from increased demand and the market may actually become monopolistic or perfect-competition in its tendencies.

You could then talk about future potential consequences of this if the subsidy was removed, and how the industry would be forced back to equilibrium; i.e. all excess firms will die out.

You could then talk about how, post-subsidy, the amount of firms left over actually EXCEEDS the amount of firms in the initial market, EVEN IF THE POST-SUBSIDY DEMAND IS THE SAME SIZE AS THE PRE-SUBSIDY DEMAND. This is because these extra firms have overcome all natural barries to entry that was stopping perfect competition in the original market!

Last edited: Mar 19, 2010
5. Mar 19, 2010

### Tre75v

Once again, I can't thank you people enough.
I very much agree with the effects on the industry, it's only week 3 though and they know we should not have touched on those topics yet,i.e. Monopoly/Oligopily etc.
The only situation I have seen the supply curve shift has been in a producer subsidy.I may not have been totally clear in that this is a consumer subsidy, in fact a rebate. I was thinking it would shift also, but it seems to be a simple income increase.I was thinking of it as a price reduction which is wrong.What I have seen is that the quantity supplied will move up a little to intersect with the new demand line as cost of producing additional units increases and if you graph it with hypothetical figures(not the graph I tried to attach yeasterday) shifting the demand curve one unit right effects a rise in the supply curve of half a unit.So the consumer gets half the subsidy, the supplier/producer gets the other half to cover costs for increasing short run production.
A shift in the supply as well curve shows an increase of total unit production at the same price, but the producer is supplying as much as he is willing to at that price, he must take up some of the subsidy and in turn calm the demand.

6. Mar 19, 2010

### imiyakawa

Yes, the consumer subsidy, in theory, should only cause a shift in the demand curve.

BUT, what I was saying is that there will actually be a slight shift in the supply curve ASWELL, as the increase in demand --> increased units needed to be produced by suppliers --> increase cost per unit (law of diminishing returns) --> shift in the supply curve to the left (a very very small shift).
- Say that this model requires the following assumption before it represents reality: The law of diminishing returns schedule's peak is surpassed by the increase in demand.
- Say that this wouldn't happen often in reality.

It matters not that you haven't covered monopoly/oligopoly market structures yet, all you have to do is give 1/2 sentences, something like: the increase in demand will not only cause current producers to increase their supply, but will endear new firms into the market which could, in potentia, transform the market structure towards either a perfectly competitive or monopolistic market.

"This consumer subsidy may actually be used to overcome market failure in the provision of specific goods whose monetary loss outweighs that of expected monetary gain (for entering the market), even if demand for such a good exists. In this instance, the consumer subsidy is acting as a surrogate for direct government intervention in the provision of the good, thus satisfying the neoclassicalist goal of privatisation. Consequently, if used for this purpose, this subsidy could actually be thought of as a Bayesian Efficiency Incentive, in that the market player (a firm) requires an incentive, direct to them or otherwise, in order to behave Pareto Optimally. However, according to contemporary economic theory, if a market failure exists it is Pareto Suboptimal. Although, if one was to consult Keyensian economics in this instance, one would be encouraged to believe that the inefficiency resulting from market failure can be reduced by intervention."
- AN ENTIRE PARAGRAPH IN YOUR ESSAY, FULLY EDITED.

Make sure you also discuss the point I made in the last paragraph of my last post.

Of course, this is beyond what you're currently expected to know, but there's nothing wrong with getting good marks.

Last edited: Mar 19, 2010
7. Mar 20, 2010

### Tre75v

Thank you so much, I can't believe that I started only 19 days ago and I not only understand what you wrote, but can formulate an opinion.I am loveing Microeconomics, but it's my first unit of a Business Degree.Are you guys doing Economics, or is this just part of your core units? I am just really loving it, but the only other unit I have to compare with is an intro to Uni one, and it is touchy feely crap, so you can't really fail.lol

8. Mar 20, 2010

### imiyakawa

I'm also doing a business degree, with a major in Economics (2nd year of uni atm). I did ECON because it's by far, in my opinion, the most enjoyable subject in a business degree: everything else seems dry and wrote-learnt in comparison, in that there is ZERO reasoning encouraged, just application of set ways of thinking/formula. Sure, this may contribute to the productive process in a similar way an economics graduate might, but god is it boring.
What country are you doing your degree in? Australia? (you use the word "heaps" and you call uni uni). I go to UTS.

Last edited: Mar 20, 2010
9. Mar 21, 2010

### CRGreathouse

No, actually. The production cost per unit will rise by the law of diminishing returns, but this is a movement along the supply curve, not a shift in the supply curve.

10. Mar 21, 2010

### imiyakawa

Only an increase in price can cause a movement along the supply curve. Any increase in the cost of production causes the supply curve to shift.

Wikipedia:
'When the suppliers' costs change for a given output, the supply curve shifts in the same direction.'

bized.co.uk:
'Therefore, an increase in the costs of production will cause a leftward shift in the supply curve.'

Last edited: Mar 21, 2010
11. Mar 21, 2010

### Tre75v

costs change for a given output,

I was thinking the supply curve would shift too, I think when they say cost change of given output they mean that the cost of producing at current levels increases.and if the demand had not increased nothing would have changed production cost of the given output. so the extra demand at say $500(what my essay discusses) will not be fully met as suppliers don't want to produce that quantity at that price..the rationing function of prices says that the extra demand at$500 more income will cause under supply, so customers will bid prices up due to limited stock, as well as the extra cost or producing additional units for the producer.They naturally will meet in the middle, half saved by the consumer, half to the producer to make it worth their while, and government has invested in long term solutions and saved on dams and desalinisation plants.Win,win,win.
Oh, it's about the water tank subsidy by the way

12. Mar 21, 2010

### Tre75v

I'm doing online study through Open Universities, I just didn't want to drive into the city every day and hang out with people half my age, feel like a pervert.lol, and I can study through different Universities.The only problem is you become your own lecturer, and youtube has been my best friend.lol. I'm base in Brisbane, and I am in my first study period of my first year, bit scary, we have 2 units per study period, 4 SP's per year.I think it may be different on campus? I have started on Bachelor of Business Studies, but like you, I am leaning towards Bachelor of Business, with economics major.Might see how this unit goes before I decide.

13. Mar 22, 2010

### imiyakawa

Ah yes, the following confusing sources don't help:
• 'A shift in the supply curve is caused by a change in any non-price determinant of supply.'
• 'an increase in the costs of production will cause a leftward shift in the supply curve.'

Of course,
(A) it'll cause a movement along the supply curve
(B) the supply curve will be curved as an arc with a trough.

-----

At UTS we can either do 4 subjects a semester or 2, depending on your preference. Truthfully I would've liked to do my degree on-line, I'm always skipping my lectures because it's such a hassle to go when I can read the slides/do the textbook stuff and get away with that way.

Last edited: Mar 22, 2010
14. Mar 22, 2010

### imiyakawa

15. Mar 22, 2010

### Tre75v

That's a price ceiling (price ceiling)"...is the maximum legal price a seller may charge for a product or service." in this case to clear a surplus, and it seems the government is subsidising the producer to pay international prices. My example is a subsidy in the form of a rebate to the consumer, thus increasing income and demand.
no wonder this is a theoretical science if you sounded convincing enough nobody could dispute what you say.lol

16. Mar 22, 2010

### Tre75v

On another note, I have a question about price elasticity of demand on the rainwater tanks.
Determinants are Substitutability,proportion of income, Luxuries v Necessities and time.
I have down it is a substitute for tap water, and the subsidy makes it more affordable tahn before, plus increases in water bills mean that the one off expense works out less costly, also the $500, even though it ends up as$250 real, as a reasonably high portion of income, I think it is a luxury as we have domestic water, but water restrictions mean we can't wash cars and water gardens, time frame is 6 years, so consumer tastes will swing as habits are broken.Any thoughs before I hand this in.I hate looking like a fool, so I am second guessing myself

17. Mar 22, 2010

### Tre75v

BTW, thanks heaps for that link, a bit advanced for me, but that's the best way to learn.

18. Mar 23, 2010

### mel*k

Hi Tre75v,
Just wanted to thankyou for your post I am trying to work out the same question as you are. I am finding it quite hard to get my head around economic models and subsidies, are you moving the demand curve to the right as there will be an increase in demand and leaving the supply curve as is? or will the supply curve shift too?

19. Mar 23, 2010