2.2.2

Subsidies & Price Controls

Test yourself

Subsidies

Governments pay producers subsidies to help keep the price of products low.

Illustrative background for Encouraging production/consumptionIllustrative background for Encouraging production/consumption ?? "content

Encouraging production/consumption

  • Subsidies can correct market failure by encouraging the consumption and production of a good with positive externalities.
    • This is represented on the diagram by a shift to the right in supply, toward a more socially optimal level.
Illustrative background for Advantages of subsidies Illustrative background for Advantages of subsidies  ?? "content

Advantages of subsidies

  • Subsidies can reduce the cost of a product and allow a firm to exploit economies of scale.
    • This will improve long-run efficiency and competitiveness abroad.
  • Consumer preferences may change as a result of a subsidy.
Illustrative background for Disadvantages of subsidiesIllustrative background for Disadvantages of subsidies ?? "content

Disadvantages of subsidies

  • Subsidies may encourage laziness from producers because they do not need to be as efficient.
  • There is also an opportunity cost to a subsidy.
  • Elasticity of demand determines how effective a subsidy is.
  • Subsidised goods may be of a lower standard than alternatives they're trying to replace.

Minimum and Maximum Price Controls

Governments can influence supply and demand by enforcing maximum and minimum prices.

Illustrative background for Maximum priceIllustrative background for Maximum price ?? "content

Maximum price

  • A maximum price is a policy to increase consumption levels of a good.
  • If the new maximum price is above equilibrium, there will be no change.
  • If the new maximum price is below equilibrium, there will be more demand but a shortage of supply, leading to excess demand.
  • So although more people can now afford the good, less people can have it as the supply is restricted.
  • This might lead to the good being sold in a black market.
Illustrative background for Minimum priceIllustrative background for Minimum price ?? "content

Minimum price

  • A minimum price can be used to correct failures that can happen under monopsony power.
  • If the new minimum price is below equilibrium, there will be no change.
  • If the new minimum price is above equilibrium, there will be less demand but increased supply, leading to excess supply.
Illustrative background for Pros and cons of a maximum priceIllustrative background for Pros and cons of a maximum price ?? "content

Pros and cons of a maximum price

  • Pros:
    • This protects consumers from exploitation.
    • It could make sure that firms are more efficient by forcing them to pay more attention to costs.
  • Cons:
    • A maximum price could deter firms from entering the market.
    • It could also limit investment into the industry as the amount of profit firms can make is limited.
    • Firms could cut costs too aggressively in an attempt to boost profit, leading to poor quality goods, etc.
Illustrative background for Pros and cons of a minimum priceIllustrative background for Pros and cons of a minimum price ?? "content

Pros and cons of a minimum price

  • Pros:
    • By having a minimum price, suppliers can get a reasonable price for their goods.
  • Cons:
    • Consumers will be paying more for their goods.
    • Resources are wasted when excess goods are destroyed.
    • Resources are allocated inefficiently - they could have been used elsewhere instead of producing excess supply.
    • Potential high opportunity cost, because governments could spend on other schemes.

Jump to other topics

1Introduction to Markets

2Market Failure

3The UK Macroeconomy

4The UK Economy - Policies

5Business Behaviour

6Market Structures

7A Global Perspective

8Finance & Inequality

9Examples of Global Policy

Go student ad image

Unlock your full potential with GoStudent tutoring

  • Affordable 1:1 tutoring from the comfort of your home

  • Tutors are matched to your specific learning needs

  • 30+ school subjects covered

Book a free trial lesson