Protectionist Subsidies (Edexcel IGCSE Economics)

How Do Subsidies Work?

Spec point — 2.2.2c

• A subsidy is an amount of money paid to the firm by the government for each unit produced

• It lowers the cost of production for domestic firms, and as a result, they can increase output and lower prices

  • With lower prices their goods/services are more competitive internationally
  • The level of exports increases

• The increased output may result in increased domestic employment

The supply of solar panels increases in the EU due to a per unit subsidy

Diagram analysis

• To help meet its climate change targets and lower household energy bills, the EU has provided a subsidy to solar panel retailers

  • This causes an **increase in supply **of S₁ → S₂

• At the original market clearing price of P₁, a condition of** excess supply** now exists (surplus)

  • The supply of solar panels is greater than the demand

• In response, sellers in the EU lower prices

  • This causes an expansion of demand and a contraction of supply, leading to a new market equilibrium at P₂Q₂
  • The equilibrium price (P₂) is lower, and the equilibrium quantity (Q₂) is higher than before
  • The excess supply in the market has been cleared

Evaluation of Subsidies

Spec point — 2.2.2c

An Evaluation of Subsidies

• Subsidies often allow domestic firms to grow as they have limited competition from businesses abroad

Evaluating Subsidies

Worked Example Which method of protectionism is used to reduce the price of exports?

A. **Tariffs

B. Free Trade

C. Quotas

D. Subsidies

Final answer: D is the correct answer.**

Subsides lower the cost of producing an output and allow the firm to pass on the lower costs in the form of lower prices.

A is incorrect, as this would raise the price of imports

B is incorrect, as free trade would have no direct effect on lowering the price of export.

C is incorrect, as this would raise the price of imports