Question

Identify using capital letters the areas on your diagram that represents the dead-weight loss associated with the subsidy. Provide an explanation for your answer.

Answer 1

In the above graph, equilibrium occurs when demand = supply. At equilibrium point, price is 6 and quantity traded is 2. If a subsidy of $4 is given which falls evenly among consumers and producers. It will raise price received by producers to $8 and price consumers pay reduce to $4. This will raise quantity traded to 3 units. Deadweight loss in this market due to subsidy is area of portion H due to economic inefficiency.