Question

A profit-maximizing dairy farm is currently producing 10,000 gallons of milk per day. The government is considering two alternative policies. One is to give the farm a lump sum subsidy of $500 per month. The other policy is to give the farm a subsidy of $.05 per gallon of output.

a. Both kinds of subsidy will increase production at this farm.

b. Neither subsidy will affect production at this farm, since output is determined by profit maximization.

c. Production at this farm will be increased if the per-unit subsidy is adopted but not if the lump sum subsidy is adopted.

d. Which subsidy has the greater effect on production at this farm depends on whether fixed costs are greater than variable costs.

e. Production will be increased by either kind of subsidy if and only if there are not decreasing returns to scale.

Answer 1

Answer : The correct option is c.

Because the government gives lump sum subsidy of $500 per month in one policy. In another one policy the government gives $0.05 subsidy on per gallon milk production. The firm produces 10000 gallon milk per day. In per unit subsidy policy, the total subsidy in per day becomes (0.05×10000) = $500 per day.

Now we can see here that by the per unit subsidy policy the firm gets $500 in per day whereas in lump sum subsidy policy the gets $500 in per month. So, it is clear that the firm will go to adopt the per unit subsidy policy to increase the production level as this policy gives more subsidy in comparison to lump sum subsidy policy.