1.3.3

Subsidies & Price Controls

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Subsidies

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

Encouraging production/consumption

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.
Advantages of subsidies

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.
Disadvantages of subsidies

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.

Maximum price

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.
Minimum price

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.
Pros and cons of a maximum price

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.
Pros and cons of a minimum price

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
1

Microeconomics

1.1

Competitive Markets: Demand & Suply

1.1.1Markets & Demand1.1.2Diminishing Marginal Returns1.1.3Supply1.1.4Market Equilibrium1.1.5Price Mechanism1.1.6Consumer & Producer Surplus1.1.7IB Multiple Choice - Demand1.1.8IB Multiple Choice - Supply
1.2

Elasticity

1.2.1Elasticities of Demand1.2.2Factors Affecting Price Elasticity of Demand1.2.3Elasticity of Supply1.2.4Price Elasticity of Supply1.2.5IB Multiple Choice - Price Elasticity of Demand1.2.6IB Multiple Choice - Price Elasticity of Supply1.2.7IB Multiple Choice - Other Elasticities
1.3

Government Intervention

1.3.1Indirect Taxes & Subsidies1.3.2Application Question - Taxing Prices or Quantities1.3.3Subsidies & Price Controls1.3.4Deadweight Loss & Government Intervention1.3.5Elasticity & Tax Incidence1.3.6IB Multiple Choice - Government Intervention
1.4

Market Failure

1.4.1Types of Market Failure1.4.2Introduction to Externalities1.4.3Negative Externalities1.4.4Policy for Negative Externalities1.4.5Positive Externalities1.4.6The Deadweight Welfare Loss of Externalities1.4.7Case Study - The Externalities of Education1.4.8Public Goods & the Free-Rider Problem1.4.9Asymmetric Information1.4.10End of Topic Test - Market Failure1.4.11Application Questions - Market Failure
1.5

HL: Theory of the Firm & Market Structures

1.5.1Theory of the Firm & Market Structures
2

Macroeconomics

2.1

The Level of Overall Economic Activity

2.1.1The Circular Flow of Income2.1.2Defining GDP2.1.3Limitations of GDP2.1.4IB Multiple Choice - Economic Indicators2.1.5Business Cycles2.1.6Output Gaps
2.2

Aggregate Demand & Aggregate Supply

2.2.1The Aggregate Demand Curve2.2.2Components of Aggregate Demand2.2.3Shape of the Aggregate Demand Curve2.2.4Shifts in Aggregate Demand2.2.5IB Multiple Choice - Aggregate Demand2.2.6Short & Long-Run Aggregate Supply2.2.7Alternative Models of LRAS2.2.8Equilibrium in the AD-AS Model2.2.9Output Gaps & the AD-AS Model
2.3

Macroeconomic Objectives

2.3.1Introduction to Unemployment2.3.2Limitations of Unemployment2.3.3Types of Unemployment2.3.4Causes & Impact of Unemployment2.3.5Defining Inflation2.3.6Measuring Inflation2.3.7Use of Index Numbers2.3.8The Consumer Price Index2.3.9Consequences of Inflation2.3.10Causes of Inflation2.3.11Inflation & Unemployment Tradeoff2.3.12The Short-Run Phillips Curve2.3.13The Long-Run Phillips Curve
2.4

Economic Growth, Poverty & Inequality

2.4.1Measuring Economic Growth2.4.2Determinants of Productivity2.4.3Economic Growth & Productivity2.4.4Absolute & Relative Poverty2.4.5Inequality2.4.6Inequality 22.4.7Lorenz Curve2.4.8Government Policy on Poverty2.4.9End of Topic Test - Poverty & Inequality2.4.10Application - Inequality & Poverty
2.5

Fiscal Policy

2.5.1Introduction to Fiscal Policy2.5.2Fiscal Policy and AD-AS Model2.5.3Fiscal Policy Lags2.5.4Automatic Stabilizers2.5.5IB Multiple Choice - Fiscal Policy
2.6

Monetary Policy

2.6.1Objectives of Monetary Policy2.6.2Monetary Policy Implementation2.6.3Monetary Policy & AD-AS Model2.6.4Monetary Policy Lags & Pitfalls
2.7

Supply-Side Policies

2.7.1Supply-Side Policies2.7.2Supply-Side Policies 2
3

The Global Economy

3.1

International Trade

3.1.1Globalisation3.1.2Globalisation for LEDCs3.1.3Globalisation for MEDCs3.1.4Comparative Advantage & Trade3.1.5Protectionism3.1.6Arguments for Protectionism3.1.7Arguments Against Protectionism3.1.8End of Topic Test - Globalisation & Trade3.1.9Case Study - Globalisation & Trade
3.2

Exchange Rates

3.2.1Floating Exchange Rates3.2.2Fixed Exchange Rate3.2.3Effect of a Stronger & Weaker Dollar
3.3

The Balance of Payments

3.3.1Balance of Payments3.3.2Balance of Payments 23.3.3FDI & Reducing a BoP Deficit
3.4

Economic Integration

3.4.1Customs Unions & WTO3.4.2Merged Currency
3.5

Terms of Trade

3.5.1Absolute & Comparative Advantage3.5.2Gains from Trade3.5.3Terms of Trade3.5.4IB Multiple Choice - Comparative Advantage & Trade
3.6

Economic Development

3.6.1Factors Influencing Growth & Development3.6.2International Institutions3.6.3Measures of Development3.6.4Barriers to Development3.6.5Case Study - The Bottom Billion3.6.6End of Topic Test - Emerging & Developing
3.7

The Role of Domestic & International Factors

3.7.1Interventionist Strategies3.7.2Development Strategies3.7.3Development Promotion Policies3.7.4End of Topic Test - Growth & Global Development3.7.5Application Questions -Growth & Global Development
3.8

The Role of International Trade

3.8.1International Institutions3.8.2End of Topic Test - Globalisation & Trade
3.9

The Role of Foreign Aid

3.9.1Aid3.9.2Limitations of Aid3.9.3Support for Aid3.9.4Application Questions - Developing Countries

Practice questions on Subsidies & Price Controls

Can you answer these? Test yourself with free interactive practice on Seneca — used by over 10 million students.

  1. 1
    Which of the following is a disadvantage of subsidies?Multiple choice
  2. 2
    Which of the following are advantages of subsidies?True / false
  3. 3
    Which government policy could lead to the excess demand shown in the diagram?Multiple choice
  4. 4
    Cons of a maximum price:True / false
  5. 5
    Cons of a minimum price:Fill in the list
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Application Question - Taxing Prices or Quantities

Deadweight Loss & Government Intervention