Subsidies for Positive Externalities

Subsidies involves the government paying part of the cost to the firm to encourage more consumption, therefore supply shifts to the right.

Diagram of Subsidy on Positive Externality

• Subsidy = P2- P0
• The supply curve shifts to S2 and Price falls to P2
• People will now consume more at Q2
• Q1 = Social Efficiency: because SMC = SMB

Advantages of Subsidies

• a.) Increases social efficiency
  b.) Provides goods/services at a cheaper price

Disadvantages of Subsidies

• Is expensive and will require higher taxes.
• Difficult to estimate positive externality
• Giving subsidies to firms may encourage inefficiency, because the firms will rely on government aid.
• Govt Failure: The govt may have poor information about the service