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
