in a downward vertical shift in the supply curve for good X. Be careful here! This is not a
“decrease in supply”!Since subsidies come from the government, they are certainly not
designed as revenue-generating devices. Ideally, their primary goal is to support producers of
a good or service that has significant benefit to society so that it can be produced in greater
quantities and at lower prices to consumers. This form of positive externality is also explored
in Chapter 11. Public university education is a common example of this type of subsidy.
Figure 7.13 illustrates the market for public university education where the demand
(D 0 ) and unsubsidized supply (S 0 ) curves produce an equilibrium price P 0 (tuition) and
quantity Q 0 (degrees earned). If government decides that provision of bachelor’s degrees is
a beneficial service to society, a per student subsidy Uis given to the public university
system. The subsidy decreases tuition to P 1 and increases the number of undergraduate
degrees received. Notice that the producers receive, after the subsidy, (P 1 + U) for each stu-
dent at the new quantity of Q 1.88 á Step 4. Review the Knowledge You Need to Score High
“Taxes and
subsidies are
usually tested in
both the
multiple-choice
section and
as part of a
free-response
question.”
—AP TeacherQuantityPrice $ S 0SuD 0= UQ 1P 1P 1 +UP 0Q 0Figure 7.13How does the price elasticity of demand factor into this outcome? If the demand for
public university education is elastic, then a relatively small percentage decrease in the price
of tuition creates a sizable percentage increase in the number of degrees earned by members
of society. If demand is price inelastic, it takes a much larger percentage decrease in the price
to achieve the same percentage increase in degrees earned.Price Floors
In some cases, the market-determined equilibrium price P 0 is deemed “too low” by some
members of society. Typically, suppliers who feel that the market price is not high enough
to cover production costs and earn a decent living make this argument. If the government
agrees with this argument, a price floormay be installed at some level above the equilib-
rium price. A price floor is a legal minimum price below which the product cannot be sold.
Another example is a minimum wage in a market for labor. A price floor in the market for
milk is seen in Figure 7.14.
The resulting surplus of milk is not eliminated through the market, and the govern-
ment usually agrees, as part of the price floor arrangement, to purchase the surplus milk.
For consumers, the result of the policy is a higher price of milk (and other dairy products)
at grocery stores, a decrease in milk consumption, and an increase in taxpayer-supported
government spending. The amount of government spending to purchase the surplus is
equal to (PF) ¥surplus. If the price elasticities of demand or supply are large, the surplus,
and resulting government spending, rises.
By providing an incentive for producers to produce beyond where the MB =MC, the
price floor policy causes efficiency to be lost. For gallons of milk above Q 0 , MC >MB; thereKEY IDEAhttp://www.ebook3000.com