Suggested Answers of BT2 Revision Package - ASKnLearn

Subsidies to ConsumersWith government intervention, a subsidy of AB per unit to consumers will shift the demandcurve from MPB to MSB as consumers are ‘encouraged’ to increase consumption, resultingin the socially optimal level, Q 2 where MSC = MSB .Cost/benefitMSC = MPCD• BC• AMSB = MPB + MEB0Q 1 Q 2MPBQuantityFigure 2Subsidies to ProducersSubsidies given to producers reduce the cost of supplying products. This is shown in Figure3. The equilibrium without government intervention is at output Q 1 where MPC = MPB or D 1= S 1 . In this case, marginal external benefit is added to the MPB curve to give the MSB ormarginal social benefit curve.If the government subsidises the production of arts performances, the supply curve moves tothe right from S 1 to S 2 , which equals MPC minus the subsidy. The marginal cost of supplyingthe good is reduced by the amount of subsidy and the vertical distance GH is equal to thevalue of the subsidy provided. Producers will be able to sell output Q 2 at a price of P 3 whichis where D 1 crosses S 2 . The production and consumption level would be socially optimal.