Question

True or false: Granting subsidy on food will increase social welfare. Explain your answer with a graph.

Answer 1

False

As we see in the diagram a subsidy will shift the supply curve to the right and this will reduce the price consumers pay (P2) increase the price producer receive (P1) and quantity is increased from Q0 to Q1.

Now cost of subsidy is area (A + B + F + C + D + E). Consumer surplus rises by area (C + D + E) and producer surplus rises by area (A + B). Hence there is a net loss to the society as a whole and this is meausred by

(A + B + F + C + D + E) - (C + D + E) - (A + B) = area F

This is the deadweight loss of subsidy.