Question

Suppose there is a market at its competitive equilibrium.
Demand p = 100 - QD

Supply p = 20 + (QS /3) The government introduces a subsidy of s = $4 per unit of the good sold and bought.

(a) Draw the graph for the demand and supply before subsidy.

(b) What is the equilibrium price and quantity before the subsidy and after the subsidy?

(c) Looking at the prices buyers pay and sellers receive after the subsidy compared to the no subsidy case, do buyers or sellers receive more of the subsidy? How much of the $4/unit subsidy is received by the buyers and how much by the sellers?

(d) Calculate the price elasticities of demand and supply at the equilibrium before the subsidy. Confirm that the elasticities are inversely proportional to the shares of the subsidy each side (buyers and sellers) receive?

(e) What is the consumer surplus CS and producer surplus PS before and after the subsidy? What is the cost to the government of this subsidy program? What is the DWL (deadweight loss) that comes with the subsidy policy?

Answer 1