Government intervention in the price system

The multiplier effect


A subsidy is a Government intervention in the form of financial assistance to producers which decreases their costs of production and also encourages them to increase output of the good/service.

Subsidy Features

  • The payment may be related to the number of units produced or it may in the form of a lump sum.   Because the effects of a subsidy are the opposite to the effects of a tax, a subsidy is often referred to as a negative tax.
  • A subsidy lowers the cost of production to the manufacturer and it’s precise effects effect in terms of increased quantity made available to and purchased by , consumers depends on the price elasticity of supply and price elasticity of demand
  • It’s effect on the quantity which producers would be prepared to supply would be greatest if the firm enjoy reducing economies of scale at higher levels of output and the effects would be lowest if unit cost increasing diseconomies occur at higher levels of output.
  • Similarly, the more elastic is demand in response to a change in price, the greater will the increase in demand for any reduction in price. 
  • In economic terms, they increase consumer demand and a shift of the supply curve to the right.
  • They are financed from borrowing or general taxation.
  • The amount of the subsidy = Subsidy per unit x total output.
Government subsidy
Government intervention in price system