A subsidy can be thought of as a negative, or reverse, tax where the government gives money to consumers or producers.
In his MRU video (reference below, link on right), Alex Tabarrok, lists three “economic truths” about subsidies that parallel those for Commodity Taxes:
- Who gets the subsidy does not depend on who receives the cheque from the government
- Who benefits from the subsidy does depend on the relative elasticities of demand and supply
- Subsidies must be paid for by taxpayers and they create inefficient increases in trade (deadweight loss)
The subsidy wedge
In analogy with the tax wedge, Tabarrok shows the effect of driving a subsidy wedge into the supply and demand curve. A deadweight loss is generated in the area where producers are producing at a higher cost than what buyers would be willing to pay if the good were not subsidized. In other words, a subsidy produces wasteful trades.
Deadweight loss = cost of the trades made because of the subsidy
Alex Tabarrok, Subsidies, Marginal Revolution University, 13-minute video, at http://www.mruniversity.com/courses/principles-economics-microeconomics/subsidies-definition-subsidy-wedge, accessed 29 April 2016.
Atlas topic and subject
Page created by: Ian Clark, last modified on 29 April 2016.
Image: Minute 0.15 of MRU Video, at http://www.mruniversity.com/courses/principles-economics-microeconomics/subsidies-definition-subsidy-wedge, accessed 29 April 2016.