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IAI Actuarial Core Principles · Business Economics · Government intervention in a market

A specific subsidy is paid to producers of a good. Other things equal, which outcome follows in a competitive market with a normal downward-sloping demand curve?

A producer subsidy shifts the supply curve to the right because it lowers per-unit costs. The market price falls and the quantity traded rises, so consumers gain through the lower price while producers gain through the subsidy received.

  1. ASupply shifts left and the price rises
  2. BSupply shifts right, the price falls and quantity traded risesCorrect
  3. CDemand shifts right and the price rises
  4. DQuantity traded falls because producers earn less
  5. The price stays the same and only producers gain

Explanation

A subsidy lowers marginal cost, so supply shifts right (or down). The equilibrium price falls and the quantity traded rises. Option E is wrong because consumers also gain from the lower price.

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