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IAI Actuarial Core Principles · Business Economics · How competitive markets operate

A government grants a per-unit subsidy to producers of solar panels in a competitive market. Compared with the free market, which result is correct?

A per-unit producer subsidy lowers marginal costs and shifts supply to the right. The market price paid by consumers falls and the quantity traded rises. Producers receive the lower market price plus the subsidy, so both sides share the benefit.

  1. ASupply shifts left and the market price rises
  2. BSupply shifts right, the market price falls and quantity risesCorrect
  3. CDemand shifts right and the market price rises
  4. DPrice and quantity are unchanged because the subsidy goes to firms
  5. Quantity rises but the price paid by consumers also rises

Explanation

A subsidy lowers marginal cost, shifting the supply curve down and right. With a downward-sloping demand curve, the equilibrium price paid by consumers falls and quantity rises. Producers receive the market price plus the subsidy.

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