Subsidies for Postive Externalities

Subsidies involves the government paying part of the cost to the firm. This reduces the price of the good and should encourage more consumption.

A subsidy shift the supply curve to the right.

What is Justification for Subsidising goods with positive externalities?

In a free market, people ignore the positive externalities of consumption, e.g. when cycling to work, you don't consider the reduction in pollution your decision creates.

In a free market, there is under consumption of good with positive externalities.

The free market equilibrium is at Q1. But, social efficiency occurs at Q2 (where SMB = SMC)

To increase consumption and production, the government can offer a subsidy to reduce the price and increase quantity.

Diagram of Subsidy on Positive Externality

subsidy

Advantages of Subsidies

 

Disadvantages of Subsidies

 

Essays and Revision Notes on Market Failure

Essays and Revision Notes on Government Failure