Definition

Subsidy

Monetary help (direct or indirect payment) offered by the government to firms (sometimes households) to aid in lowering costs of production.

In the context of imports and exports, there are two types of subsidies:

Production subsidies.
Export subsidies.

Production subsidies

Subsidies where government gives payments to domestic firms competing with imports in order to encourage them to produce more and protect them.

Diagram

Observing the diagram, before the subsidy, the economy is in free trade and operates at the world price $P_w$ which is below the domestic price $P_d$ that existed without free trade.

The quantity supplied by domestic producers is $Q_1$ and quantity demanded by consumers is $Q_2$.
The excess demand $Q_2 - Q_1$ is the initial quantity of imports.
The government sets a subsidy $s$ per unit, causing the supply curve to shift down by $s$ from $S_{d1}$ to $S_{d2}$
This indicates an increased supply since the firm gets a subsidy for each unit it produces.
Therefore, this subsidy increases the price that producers receive from world price $P_w$ to world price plus subsidy $P_w + s$ per unit.
However the price paid by consumers still stays at $P_w$.

Hence after the production subsidy:

The quantity supplied is $Q_3$ and the quantity demanded is still $Q_2$.
Hence the excess demand fall, thus the imports have fallen and producers earn an extra $s$ per unit.

The effects of a production subsidy

Winners

Domestic Producers

Domestic producers are supplying more ($Q_3$ instead of $Q_1$) at a higher price ($P_w + s$), earning higher revenues.
Producer surplus increases by the area marked as $a$, indicating the gain from the new prices and trade restriction.

Definition

Producer surplus

The difference between the price sellers receive and the lowest price that they are willing and able to accept.

Workers

As domestic producers now produce and sell a larger quantity, the employment in the industry would be protected and increase as well.

Neutral

Unlike the the restrictions before, consumers don't face a higher price since they still purchase at $P_w$ and the same quantity $Q_2$.

Note

They switch consumption from imported goods to domestic ones, but since the price is the same, it doesn't matter to them.

Losers

Government

The government has to pay for the subsidy negatively affecting their budget.
This can be seen by the area of the subsidy $s$ multiplied by the quantity supplied $Q_3$.
Also creates an opportunity cost as the tax money could've been used elsewhere.

Inefficiency of production

The reason world price $P_w$ is smaller than domestic price without trade $P_d$ is because foreign producers are more efficient.
The increase in quantity supplied from $Q_1$ to $Q_3$ represents the increase in domestic production that is inefficient as there is a waste of scarce resources by producing at $P_w + s$ instead of $P_w$.

Foreign producers

Foreign producers now supply fewer goods ($Q_2 - Q_3$ instead of $Q_2 - Q_1$), causing their quantity sold to decrease.

Welfare effects

After the subsidy was imposed:

The producer surplus increased by $a$ due to the higher price $P_w + s$ they earn and higher quantity $Q_3$ they sell.
The consumer surplus remains unaffected.
Therefore the government expenditure on subsidy increased by $a + b = s \times Q_3$.
Resultantly, the change in social surplus is a decrease of: $a + b - a = b$.
This change leads to a welfare loss of the area $b$ due to the inefficient production created by the subsidy.

Note

When evaluating production subsidies so far:

There is no effect on consumers since from their perspective, nothing has really changed.
This leads to a lower welfare loss for the economy as the only impact is the inefficient production of producers
However, the production subsidy is also less effective in reducing imports compared to previous restrictions.

Export subsidy

Subsidies where governments make payments to firms for each unit exported to increase export competition.

Diagram

Observing the diagram, before the export subsidy, the economy is in free trade and operated at the world price $P_w$ which is above the domestic price $P_d$ that existed without free trade.

The quantity demanded by consumers is $Q_1$ and quantity supplied by domestic producers is $Q_2$.
The excess supply $Q_2 - Q_1$ is the initial quantity of exports.

Unlike before, the domestic country is now more efficient in production.

The government sets a export subsidy $s$ per unit, causing the supply curve to shift down by $s$ from $S_{d1}$ to $S_{d2}$
This indicates an increased supply since the firm gets a subsidy for each unit it produces.
The intersection of $S_{d2}$ and the world price $P_w$ determines the new quantity supplied $Q_4$
The price earned by producers is world price plus subsidy $P_w + s$

Hence after the export subsidy:

The quantity supplied rises $Q_4$ and the quantity demanded falls to $Q_3$.
Unlike production subsidy, domestic consumers also face a higher price $P_w + s$ because firms prioritise their goods towards foreign market, making it more scarce in domestic market.
Hence the excess supply increases from $Q_2 - Q_1$ to $Q_4 - Q_3$, thus the exports have increase and producers earn an extra $s$ per unit.

The effects of an export subsidy

Winners

Domestic producers

Domestic producers are supplying more ($Q_4$ instead of $Q_2$) at a higher price ($P_w + s$), earning higher revenues.
Producer surplus increases by the areas marked as $a + b + c$, indicating the gain from the new prices and trade restriction.

Definition

Producer surplus

The difference between the price sellers receive and the lowest price that they are willing and able to accept.

Workers

As domestic producers now produce and sell a larger quantity, the employment in the industry would be protected and increase as well.

Losers

Consumers

Consumers pay a higher price $P_w + s$ compared to $P_w$ and consume a lower quantity of the good at $Q_3$ compared to $Q_1$.
Consumer surplus falls by the area marked as $a+b$.

Definition

Consumer surplus

The difference between the highest price consumers are willing and able to pay for a good or service and the actual price they end up paying.

Government

The government has to pay for the subsidy negatively affecting their budget.
This can be seen by the area of the subsidy $s$ multiplied by the quantity exported $Q_4 - Q_3$.
Also creates an opportunity cost as the tax money could've been used elsewhere.

Income distribution

The higher price paid by consumers of $P_w + s$ can be seen as regressive as it takes up a larger proportion of lower incomes.

Inefficiency of production

The increase in quantity supplied from $Q_2$ to $Q_4$ represents the increase in domestic production that is inefficient as there is a waste of scarce resources by producing at $P_w + s$ instead of $P_w$.

Foreign producers

Foreign producers will now supply fewer goods since domestic producers supply more due to the increased exports.

Welfare effects

After the export subsidy was imposed:

The producer surplus increased by $a + b + c$ due to the higher price $P_w + s$ they earn and higher quantity $Q_4$ they sell.
The consumer surplus decreased by $a + b$ due to the higher prices they pay $P_w + s$ and the lower quantity they consume $Q_3$
Therefore the government expenditure on subsidy increased by $b + c + d = s \times (Q_4-Q_3)$.

The change in social surplus is a decrease of: $(b + c + d) + (a + b) - (a + b + c) = b + d$

This change leads to a welfare loss of the area $b + d$ due to the misallocation of resources created by the subsidy.

The welfare loss is higher compared to production subsidies because, alongside the inefficient production, consumers are affected negatively.

Calculating the Effects of Production Subsidy (HL Only)

The figure above showcases a production subsidy diagram with numerical values this time for calculation.

Subsidy

The subsidy can be calculated by finding the vertical shift between the two supply curves.
Consider any quantity and find the difference between the prices in the domestic supply curve $S_{d1}$ and the domestic curve plus subsidy $S_{d2}$.

Example

$P_w + s = 13$ and $P_w = 10$ hence

$$ s = P_w + s - P_w = 13 - 10 = 3$$

Imports quantity

Before the subsidy, the imports can be calculated by finding the excess demand at world price $P_w$ using the original supply curve $S_{d1}$

Example

At $P_w = \$ 10$:

The quantity imported was $12500 - 5000 = 7500$

Hence, $7500$ units of the good were imported initially.

Then after the subsidy, the imports will be the excess demand at world price $P_w$ but using the new supply curve $S_{d2}$.

Example

In this case, the quantity demanded is still $12500$ but the quantity supplied now is $8000$ thus

$$12500 - 8000 = 4500$$

thus a decrease of $3000$ units in imports

Import expenditure

By multiplying the import quantity before the subsidy and after the subsidy by the world price.
You can find the expenditure on imports before & after the subsidy respectively.

Example

Before:

$7500 \times 10 = \$ 75000$

After:

$4500 \times 10 = \$ 45000$

Hence import expenditure fell by:

$ 75000 - 45000 = \$ 30000$

Producer revenue (domestic)

For (domestic) producer revenue:

Before the subsidy, we multiply world price by initial quantity supplied
After subsidy, you multiply world price plus subsidy ($P_w + s$) with new quantity supplied.
As both price and quantity supplied increase, producers always earn more revenue.

Example

Before:

The revenue is $5000 \times 10 = \$ 50,000$

After:

The revenue is $8000 \times 13 = \$ 104,000$

Hence., the revenue of domestic producers increased by:

$ 104,000 - 50,000 = \$ 54,000$

Producer surplus

Before the subsidy, producer surplus is the area of the triangle below the world price and above the supply curve, up till the quantity sold.
After the subsidy, producer surplus is the area of the triangle below the world price plus subsidy and above the supply curve, till the quantity sold.

Example

Before:

$P_w = 10, Q_s = 5000$, and $P_{min} = 5$

Therefore we can calculate:

$$ PS = \frac{(10-5)\times 5,000}{2} = 12,500$$

Hence, producer surplus was $\$ 12,500$.

After:

$P_w + s = 13, Q_s = 8000$ and $P_{min} = 5$

Therefore we can calculate:

$$ CS = \frac{(13-5)\times 8,000}{2} = 32,000$$

Hence, producer surplus was $\$ 32,000$.

Therefore, the change in producer surplus was an increase of $\$ 19,500$.

Government expenditure

The subsidy paid in total by the government is the subsidy per unit multiplied by the units produced.

Example

Hence in this case $Q_3 = 8000$ and $s = 3$ such that

$$Government_{Expenditure} = 8000\times 3 = 24000$$

They lose $\$ 24000$

Welfare loss

The areas of triangle $b$ showcase the welfare loss which can be calculated by multiplying the subsidy by the change in quantity supplied (divided by two)

Self review

Change in quantity supplied was $8000 - 5000 = 3000$ and the subsidy is $s = 3$ such that

$WL = \frac{3000 \times 3}{2} = 4500$

Thus the welfare loss was worth $\$ 4500$

Foreign producers

Their revenues will fall proportional to the amount import expenditure falls by.

Example

From import quantity and expenditure above, this means they lost $3000$ units of import and thus lost $\$ 30000$ is revenues.

Calculating the effects of export subsidy (HL only)

The figure above showcases an export subsidy diagram with numerical values, this time for calculation.

Subsidy

The subsidy can be calculated by finding the vertical shift between the two supply curves.
Consider any quantity and find the difference between the prices in the domestic supply curve $S_{d1}$ and the domestic curve plus subsidy $S_{d2}$.

Example

$P_w + s = 23$ and $P_w = 20$ hence

$$ s = P_w + s - P_w = 23 - 20 = 3$$

Exports quantity

Before the subsidy, the exports can be calculated by finding the excess supply at world price $P_w$

Example

At $P_w = \$ 20$:

The quantity exported was $15000 - 7500 = 7500$

Hence, $7500$ units of the good were imported initially.

Then after the subsidy, the exports will be the excess supply at world price plus subsidy $P_w + s$

Example

In this case, the quantity supplied at $P_w + s = 23$ is $18000$ and the quantity demanded is $6000$ such that the export quantity is

$$18000 - 6000 = 12000 \text{ units}$$

This indicates an increase in exports of

$$12000 - 7500 = 4500 \text{units}$$

Export revenue

By multiplying the export quantity before the subsidy and after the subsidy by the world price.
You can find the revenue on exports before & after the subsidy respectively.

Example

Before:

$7500 \times 20 = \$ 150,000$

After:

$12000 \times 20 = \$ 240,000$

Hence export revenue increased by:

$ 240000 - 150000 = \$ 90000$

Consumer expenditure

Before the subsidy, the consumer expenditure was the world price multiplied by the quantity demanded
After the subsidy, the higher price paid by consumers at the world price plus subsidy multiplied by the lower quantity demanded is their expenditure.

Example

Before:

$P_w = 20$ paid by consumers and $Q_1 = 7500$ demanded such that their expenditure was

$$ 20 \times 7500 = \$ 150,000$$

After:

$P_w + s = 23$ paid by consumers and $Q_3 = 6000$ demanded such that their expenditure was

$$ 23 \times 6000 = \$ 138,000$$

Hence their expenditure fell by $150,000 - 138,000 = \$ 12,000$ but they are still worse off

Consumer surplus

Before the subsidy, consumer surplus is the area of the triangle above the world price and below the demand curve, up till the quantity bought.
After the subsidy, consumer surplus is the area of the triangle above the world price plus subsidy and below the demand curve, till the quantity bought.

Example

Before:

The quantity bought is $Q_1 = 7500$ with price $P_w = 20$ and maximum price $P_{max} = 35$ such that

$$ CS = \frac{(35 - 20) \times 7500}{2} = 56250$$

Thus the consumer surplus was initially $ \$ 56,250$

After:

The quantity bought is $Q_3 = 6000$ with price $P_w + s = 23$ and maximum price $P_{max} = 35$ such that

$$ CS = \frac{(35 - 23) \times 6000}{2} = 36000$$

Thus the consumer surplus was initially $ \$ 36,000$

This indicates a decrease in consumer surplus by $\$ 20,250$

Producer revenue (domestic)

For (domestic) producer revenue:

Before the subsidy, we multiply world price by initial quantity supplied
After subsidy, you multiply world price plus subsidy ($P_w + s$) with new quantity supplied.
As both price and quantity supplied increase, producers always earn more revenue.

Example

Before:

The revenue is $15000 \times 20 = \$ 300,000$

After:

The revenue is $18000 \times 23 = \$ 414,000$

Hence, the revenue of domestic producers increased by:

$ 414,000 - 300,000 = \$ 114,000$

Producer surplus

Before the subsidy, producer surplus is the area of the triangle below the world price and above the supply curve, up till the quantity sold.
After the subsidy, producer surplus is the area of the triangle below the world price plus subsidy and above the supply curve, till the quantity sold.

Example

Before:

$P_w = 20, Q_s = 15000$, and $P_{min} = 5$

Therefore we can calculate:

$$ PS = \frac{(20-5)\times 15,000}{2} = 112,500$$

Hence, producer surplus was $\$ 112,500$.

After:

$P_w + s$ = 23, Q_s = 18000$ and $P_{min} = 5$

Therefore we can calculate:

$$ CS = \frac{(23-5)\times 18,000}{2} = 162,000$$

Hence, producer surplus was $\$ 162,000$.

Therefore, the change in producer surplus was an increase of $\$ 49,500$.

Government Expenditure

The subsidy paid in total by the government is the subsidy per unit multiplied by the units exported.

Example

Hence in this case $Q_3 = 6000$ and $Q_4 = 18000$ so the units exported are $Q_4 - Q_3 = 12000$ with subsidy $s = 3$ such that

$$Government_{Expenditure} = 12000\times 3 = \$ 36,000$$

Welfare Loss

The areas of triangle $b + d$ showcase the welfare loss which can be calculated by:

Multiplying the subsidy by the change in quantity demanded (divided by two) for the first.
And multiplying the subsidy by the change in quantity supplied (divided by two) for the second.

Example

First triangle:

Change in quantity demanded was $7500 - 6000 = 1500$ and the subsidy is $s = 3$ such that

$b = \frac{1500 \times 3}{2} = 2250$

Second triangle:

Change in quantity supplied was $18000 - 15000 = 3000$ and the subsidy is $s = 3$ such that

$d = \frac{3000 \times 3}{2} = 4500$

Thus the welfare loss was worth $\$ 6750$

Self review

Explain how both production and export subsidies workstakeholders using a diagram.
Discuss the impact on certain stake holders.
Compare the differences between the effects of production and export subsidies.

Theory of Knowledge

Even when exports showcase a higher producer surplus, is adding export subsidies unjust on consumers?

Case study

European Union's Export Subsidy on Agricultural Products

Context:

The European Union (EU) has historically provided export subsidies to support its agricultural sector, particularly dairy, meat, and sugar. These subsidies aimed to make EU agricultural products competitive in global markets by covering the gap between high domestic production costs and lower world market prices.

Effects of the Export Subsidy:

Boost to Domestic Farmers:

Subsidies enabled European farmers to export surplus agricultural goods at competitive prices, ensuring stable income for domestic producers.

Market Distortion in Developing Countries:

Subsidized exports undercut local producers in developing countries. For example, EU-subsidized milk powder flooded African markets, reducing demand for locally produced milk and harming local dairy farmers.

The strain on EU Budget:

These subsidies were expensive for EU taxpayers, contributing to debates over reforming the EU’s Common Agricultural Policy (CAP).

Global Trade Disputes:

Export subsidies were criticized by the World Trade Organization (WTO) for creating unfair advantages and harming free trade. The WTO encouraged nations to phase out such subsidies, leading to reforms in the EU.

Questions:

How did the EU’s export subsidies help domestic farmers, and what were the unintended consequences for developing countries' agricultural sectors?
Should countries prioritize their domestic industries even if it leads to global market distortions, or is free trade a better long-term solution?

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Definition

Subsidy

Monetary help (direct or indirect payment) offered by the government to firms (sometimes households) to aid in lowering costs of production.

In the context of imports and exports, there are two types of subsidies:

Production subsidies.
Export subsidies.

Production subsidies

Subsidies where government gives payments to domestic firms competing with imports in order to encourage them to produce more and protect them.

Diagram

The quantity supplied by domestic producers is $Q_1$ and quantity demanded by consumers is $Q_2$.
The excess demand $Q_2 - Q_1$ is the initial quantity of imports.
The government sets a subsidy $s$ per unit, causing the supply curve to shift down by $s$ from $S_{d1}$ to $S_{d2}$
This indicates an increased supply since the firm gets a subsidy for each unit it produces.
Therefore, this subsidy increases the price that producers receive from world price $P_w$ to world price plus subsidy $P_w + s$ per unit.
However the price paid by consumers still stays at $P_w$.

Hence after the production subsidy:

The quantity supplied is $Q_3$ and the quantity demanded is still $Q_2$.
Hence the excess demand fall, thus the imports have fallen and producers earn an extra $s$ per unit.

The effects of a production subsidy

Winners

Domestic Producers

Domestic producers are supplying more ($Q_3$ instead of $Q_1$) at a higher price ($P_w + s$), earning higher revenues.
Producer surplus increases by the area marked as $a$, indicating the gain from the new prices and trade restriction.

Definition

Producer surplus

The difference between the price sellers receive and the lowest price that they are willing and able to accept.

Workers

As domestic producers now produce and sell a larger quantity, the employment in the industry would be protected and increase as well.

Neutral

Unlike the the restrictions before, consumers don't face a higher price since they still purchase at $P_w$ and the same quantity $Q_2$.

Note

They switch consumption from imported goods to domestic ones, but since the price is the same, it doesn't matter to them.

Losers

Government

The government has to pay for the subsidy negatively affecting their budget.
This can be seen by the area of the subsidy $s$ multiplied by the quantity supplied $Q_3$.
Also creates an opportunity cost as the tax money could've been used elsewhere.

Inefficiency of production

The reason world price $P_w$ is smaller than domestic price without trade $P_d$ is because foreign producers are more efficient.
The increase in quantity supplied from $Q_1$ to $Q_3$ represents the increase in domestic production that is inefficient as there is a waste of scarce resources by producing at $P_w + s$ instead of $P_w$.

Foreign producers

Foreign producers now supply fewer goods ($Q_2 - Q_3$ instead of $Q_2 - Q_1$), causing their quantity sold to decrease.

Welfare effects

After the subsidy was imposed:

The producer surplus increased by $a$ due to the higher price $P_w + s$ they earn and higher quantity $Q_3$ they sell.
The consumer surplus remains unaffected.
Therefore the government expenditure on subsidy increased by $a + b = s \times Q_3$.
Resultantly, the change in social surplus is a decrease of: $a + b - a = b$.
This change leads to a welfare loss of the area $b$ due to the inefficient production created by the subsidy.

Note

When evaluating production subsidies so far:

There is no effect on consumers since from their perspective, nothing has really changed.
This leads to a lower welfare loss for the economy as the only impact is the inefficient production of producers
However, the production subsidy is also less effective in reducing imports compared to previous restrictions.

Export subsidy

Subsidies where governments make payments to firms for each unit exported to increase export competition.

Diagram

The quantity demanded by consumers is $Q_1$ and quantity supplied by domestic producers is $Q_2$.
The excess supply $Q_2 - Q_1$ is the initial quantity of exports.

Unlike before, the domestic country is now more efficient in production.

The government sets a export subsidy $s$ per unit, causing the supply curve to shift down by $s$ from $S_{d1}$ to $S_{d2}$
This indicates an increased supply since the firm gets a subsidy for each unit it produces.
The intersection of $S_{d2}$ and the world price $P_w$ determines the new quantity supplied $Q_4$
The price earned by producers is world price plus subsidy $P_w + s$

Hence after the export subsidy:

The quantity supplied rises $Q_4$ and the quantity demanded falls to $Q_3$.
Unlike production subsidy, domestic consumers also face a higher price $P_w + s$ because firms prioritise their goods towards foreign market, making it more scarce in domestic market.
Hence the excess supply increases from $Q_2 - Q_1$ to $Q_4 - Q_3$, thus the exports have increase and producers earn an extra $s$ per unit.

The effects of an export subsidy

Winners

Domestic producers

Domestic producers are supplying more ($Q_4$ instead of $Q_2$) at a higher price ($P_w + s$), earning higher revenues.
Producer surplus increases by the areas marked as $a + b + c$, indicating the gain from the new prices and trade restriction.

Definition

Producer surplus

The difference between the price sellers receive and the lowest price that they are willing and able to accept.

Workers

As domestic producers now produce and sell a larger quantity, the employment in the industry would be protected and increase as well.

Losers

Consumers

Consumers pay a higher price $P_w + s$ compared to $P_w$ and consume a lower quantity of the good at $Q_3$ compared to $Q_1$.
Consumer surplus falls by the area marked as $a+b$.

Definition

Consumer surplus

The difference between the highest price consumers are willing and able to pay for a good or service and the actual price they end up paying.

Government

The government has to pay for the subsidy negatively affecting their budget.
This can be seen by the area of the subsidy $s$ multiplied by the quantity exported $Q_4 - Q_3$.
Also creates an opportunity cost as the tax money could've been used elsewhere.

Income distribution

The higher price paid by consumers of $P_w + s$ can be seen as regressive as it takes up a larger proportion of lower incomes.

Inefficiency of production

Foreign producers

Foreign producers will now supply fewer goods since domestic producers supply more due to the increased exports.

Welfare effects

After the export subsidy was imposed:

The producer surplus increased by $a + b + c$ due to the higher price $P_w + s$ they earn and higher quantity $Q_4$ they sell.
The consumer surplus decreased by $a + b$ due to the higher prices they pay $P_w + s$ and the lower quantity they consume $Q_3$
Therefore the government expenditure on subsidy increased by $b + c + d = s \times (Q_4-Q_3)$.

The change in social surplus is a decrease of: $(b + c + d) + (a + b) - (a + b + c) = b + d$

This change leads to a welfare loss of the area $b + d$ due to the misallocation of resources created by the subsidy.

The welfare loss is higher compared to production subsidies because, alongside the inefficient production, consumers are affected negatively.

Calculating the Effects of Production Subsidy (HL Only)

The figure above showcases a production subsidy diagram with numerical values this time for calculation.

Subsidy

The subsidy can be calculated by finding the vertical shift between the two supply curves.
Consider any quantity and find the difference between the prices in the domestic supply curve $S_{d1}$ and the domestic curve plus subsidy $S_{d2}$.

Example

$P_w + s = 13$ and $P_w = 10$ hence

$$ s = P_w + s - P_w = 13 - 10 = 3$$

Imports quantity

Before the subsidy, the imports can be calculated by finding the excess demand at world price $P_w$ using the original supply curve $S_{d1}$

Example

At $P_w = \$ 10$:

The quantity imported was $12500 - 5000 = 7500$

Hence, $7500$ units of the good were imported initially.

Then after the subsidy, the imports will be the excess demand at world price $P_w$ but using the new supply curve $S_{d2}$.

Example

In this case, the quantity demanded is still $12500$ but the quantity supplied now is $8000$ thus

$$12500 - 8000 = 4500$$

thus a decrease of $3000$ units in imports

Import expenditure

By multiplying the import quantity before the subsidy and after the subsidy by the world price.
You can find the expenditure on imports before & after the subsidy respectively.

Example

Before:

$7500 \times 10 = \$ 75000$

After:

$4500 \times 10 = \$ 45000$

Hence import expenditure fell by:

$ 75000 - 45000 = \$ 30000$

Producer revenue (domestic)

For (domestic) producer revenue:

Before the subsidy, we multiply world price by initial quantity supplied
After subsidy, you multiply world price plus subsidy ($P_w + s$) with new quantity supplied.
As both price and quantity supplied increase, producers always earn more revenue.

Example

Before:

The revenue is $5000 \times 10 = \$ 50,000$

After:

The revenue is $8000 \times 13 = \$ 104,000$

Hence., the revenue of domestic producers increased by:

$ 104,000 - 50,000 = \$ 54,000$

Producer surplus

Before the subsidy, producer surplus is the area of the triangle below the world price and above the supply curve, up till the quantity sold.
After the subsidy, producer surplus is the area of the triangle below the world price plus subsidy and above the supply curve, till the quantity sold.

Example

Before:

$P_w = 10, Q_s = 5000$, and $P_{min} = 5$

Therefore we can calculate:

$$ PS = \frac{(10-5)\times 5,000}{2} = 12,500$$

Hence, producer surplus was $\$ 12,500$.

After:

$P_w + s = 13, Q_s = 8000$ and $P_{min} = 5$

Therefore we can calculate:

$$ CS = \frac{(13-5)\times 8,000}{2} = 32,000$$

Hence, producer surplus was $\$ 32,000$.

Therefore, the change in producer surplus was an increase of $\$ 19,500$.

Government expenditure

The subsidy paid in total by the government is the subsidy per unit multiplied by the units produced.

Example

Hence in this case $Q_3 = 8000$ and $s = 3$ such that

$$Government_{Expenditure} = 8000\times 3 = 24000$$

They lose $\$ 24000$

Welfare loss

The areas of triangle $b$ showcase the welfare loss which can be calculated by multiplying the subsidy by the change in quantity supplied (divided by two)

Self review

Change in quantity supplied was $8000 - 5000 = 3000$ and the subsidy is $s = 3$ such that

$WL = \frac{3000 \times 3}{2} = 4500$

Thus the welfare loss was worth $\$ 4500$

Foreign producers

Their revenues will fall proportional to the amount import expenditure falls by.

Example

From import quantity and expenditure above, this means they lost $3000$ units of import and thus lost $\$ 30000$ is revenues.

Calculating the effects of export subsidy (HL only)

The figure above showcases an export subsidy diagram with numerical values, this time for calculation.

Subsidy

The subsidy can be calculated by finding the vertical shift between the two supply curves.
Consider any quantity and find the difference between the prices in the domestic supply curve $S_{d1}$ and the domestic curve plus subsidy $S_{d2}$.

Example

$P_w + s = 23$ and $P_w = 20$ hence

$$ s = P_w + s - P_w = 23 - 20 = 3$$

Exports quantity

Before the subsidy, the exports can be calculated by finding the excess supply at world price $P_w$

Example

At $P_w = \$ 20$:

The quantity exported was $15000 - 7500 = 7500$

Hence, $7500$ units of the good were imported initially.

Then after the subsidy, the exports will be the excess supply at world price plus subsidy $P_w + s$

Example

In this case, the quantity supplied at $P_w + s = 23$ is $18000$ and the quantity demanded is $6000$ such that the export quantity is

$$18000 - 6000 = 12000 \text{ units}$$

This indicates an increase in exports of

$$12000 - 7500 = 4500 \text{units}$$

Export revenue

By multiplying the export quantity before the subsidy and after the subsidy by the world price.
You can find the revenue on exports before & after the subsidy respectively.

Example

Before:

$7500 \times 20 = \$ 150,000$

After:

$12000 \times 20 = \$ 240,000$

Hence export revenue increased by:

$ 240000 - 150000 = \$ 90000$

Consumer expenditure

Before the subsidy, the consumer expenditure was the world price multiplied by the quantity demanded
After the subsidy, the higher price paid by consumers at the world price plus subsidy multiplied by the lower quantity demanded is their expenditure.

Example

Before:

$P_w = 20$ paid by consumers and $Q_1 = 7500$ demanded such that their expenditure was

$$ 20 \times 7500 = \$ 150,000$$

After:

$P_w + s = 23$ paid by consumers and $Q_3 = 6000$ demanded such that their expenditure was

$$ 23 \times 6000 = \$ 138,000$$

Hence their expenditure fell by $150,000 - 138,000 = \$ 12,000$ but they are still worse off

Consumer surplus

Before the subsidy, consumer surplus is the area of the triangle above the world price and below the demand curve, up till the quantity bought.
After the subsidy, consumer surplus is the area of the triangle above the world price plus subsidy and below the demand curve, till the quantity bought.

Example

Before:

The quantity bought is $Q_1 = 7500$ with price $P_w = 20$ and maximum price $P_{max} = 35$ such that

$$ CS = \frac{(35 - 20) \times 7500}{2} = 56250$$

Thus the consumer surplus was initially $ \$ 56,250$

After:

The quantity bought is $Q_3 = 6000$ with price $P_w + s = 23$ and maximum price $P_{max} = 35$ such that

$$ CS = \frac{(35 - 23) \times 6000}{2} = 36000$$

Thus the consumer surplus was initially $ \$ 36,000$

This indicates a decrease in consumer surplus by $\$ 20,250$

Producer revenue (domestic)

For (domestic) producer revenue:

Before the subsidy, we multiply world price by initial quantity supplied
After subsidy, you multiply world price plus subsidy ($P_w + s$) with new quantity supplied.
As both price and quantity supplied increase, producers always earn more revenue.

Example

Before:

The revenue is $15000 \times 20 = \$ 300,000$

After:

The revenue is $18000 \times 23 = \$ 414,000$

Hence, the revenue of domestic producers increased by:

$ 414,000 - 300,000 = \$ 114,000$

Producer surplus

Before the subsidy, producer surplus is the area of the triangle below the world price and above the supply curve, up till the quantity sold.
After the subsidy, producer surplus is the area of the triangle below the world price plus subsidy and above the supply curve, till the quantity sold.

Example

Before:

$P_w = 20, Q_s = 15000$, and $P_{min} = 5$

Therefore we can calculate:

$$ PS = \frac{(20-5)\times 15,000}{2} = 112,500$$

Hence, producer surplus was $\$ 112,500$.

After:

$P_w + s$ = 23, Q_s = 18000$ and $P_{min} = 5$

Therefore we can calculate:

$$ CS = \frac{(23-5)\times 18,000}{2} = 162,000$$

Hence, producer surplus was $\$ 162,000$.

Therefore, the change in producer surplus was an increase of $\$ 49,500$.

Government Expenditure

The subsidy paid in total by the government is the subsidy per unit multiplied by the units exported.

Example

Hence in this case $Q_3 = 6000$ and $Q_4 = 18000$ so the units exported are $Q_4 - Q_3 = 12000$ with subsidy $s = 3$ such that

$$Government_{Expenditure} = 12000\times 3 = \$ 36,000$$

Welfare Loss

The areas of triangle $b + d$ showcase the welfare loss which can be calculated by:

Multiplying the subsidy by the change in quantity demanded (divided by two) for the first.
And multiplying the subsidy by the change in quantity supplied (divided by two) for the second.

Example

First triangle:

Change in quantity demanded was $7500 - 6000 = 1500$ and the subsidy is $s = 3$ such that

$b = \frac{1500 \times 3}{2} = 2250$

Second triangle:

Change in quantity supplied was $18000 - 15000 = 3000$ and the subsidy is $s = 3$ such that

$d = \frac{3000 \times 3}{2} = 4500$

Thus the welfare loss was worth $\$ 6750$

Self review

Explain how both production and export subsidies workstakeholders using a diagram.
Discuss the impact on certain stake holders.
Compare the differences between the effects of production and export subsidies.

Theory of Knowledge

Even when exports showcase a higher producer surplus, is adding export subsidies unjust on consumers?

Case study

European Union's Export Subsidy on Agricultural Products

Context:

Effects of the Export Subsidy:

Boost to Domestic Farmers:

Subsidies enabled European farmers to export surplus agricultural goods at competitive prices, ensuring stable income for domestic producers.

Market Distortion in Developing Countries:

Subsidized exports undercut local producers in developing countries. For example, EU-subsidized milk powder flooded African markets, reducing demand for locally produced milk and harming local dairy farmers.

The strain on EU Budget:

These subsidies were expensive for EU taxpayers, contributing to debates over reforming the EU’s Common Agricultural Policy (CAP).

Global Trade Disputes:

Export subsidies were criticized by the World Trade Organization (WTO) for creating unfair advantages and harming free trade. The WTO encouraged nations to phase out such subsidies, leading to reforms in the EU.

Questions:

How did the EU’s export subsidies help domestic farmers, and what were the unintended consequences for developing countries' agricultural sectors?
Should countries prioritize their domestic industries even if it leads to global market distortions, or is free trade a better long-term solution?

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1. Introduction to Economics2 subtopics

2. Microeconomics12 subtopics

3. Macroeconomics7 subtopics

4. The Global Economy10 subtopics

4.2.3 Subsidy/export subsidy Notes

Production subsidies

Diagram

The effects of a production subsidy

Winners

Domestic Producers

Workers

Neutral

Losers

Government

Inefficiency of production

Foreign producers

Welfare effects

Export subsidy

Diagram

The effects of an export subsidy

Winners

Domestic producers

Workers

Losers

Consumers

Government

Income distribution

Inefficiency of production

Foreign producers

Welfare effects

Calculating the Effects of Production Subsidy (HL Only)

Subsidy

Imports quantity

Import expenditure

Producer revenue (domestic)

Producer surplus

Government expenditure

Welfare loss

Foreign producers

Calculating the effects of export subsidy (HL only)

Subsidy

Exports quantity

Export revenue

Consumer expenditure

Consumer surplus

Producer revenue (domestic)

Producer surplus

Government Expenditure

Welfare Loss

European Union's Export Subsidy on Agricultural Products

Context:

Effects of the Export Subsidy:

Questions:

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Want a cheatsheet?

1. Introduction to Economics2 subtopics

2. Microeconomics12 subtopics

3. Macroeconomics7 subtopics

4. The Global Economy10 subtopics

Production subsidies

Diagram

The effects of a production subsidy

Winners

Domestic Producers

Workers

Neutral

Losers

Government

Inefficiency of production

Foreign producers

Welfare effects

Export subsidy

Diagram

The effects of an export subsidy

Winners

Domestic producers

Workers