Subsidies
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0:00 - 0:03♪ [music] ♪
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0:09 - 0:11- [Prof. Alex Tabarrok] Today we're
going to start looking at subsidies. -
0:11 - 0:13We're going to move quite quickly
-
0:13 - 0:16because if you've understood
the material on taxes, -
0:16 - 0:19the material on subsidies
should follow pretty easily. -
0:19 - 0:22However, if you haven't
understood the material on taxes, -
0:22 - 0:25this is going to be
even more mysterious. -
0:25 - 0:27So make sure you understand taxes
-
0:27 - 0:29before we move on to subsidies.
-
0:29 - 0:30Here we go.
-
0:35 - 0:39Now a subsidy is really
just a negative or a reverse tax. -
0:39 - 0:40Instead of taking money,
-
0:40 - 0:44the government gives money
to consumers or producers. -
0:44 - 0:47Now here are some
economic truths about subsidy. -
0:47 - 0:50Who gets the subsidy
does not depend -
0:50 - 0:53on who receives the check
from the government. -
0:53 - 0:56Once again,
the legal incidence of the subsidy -- -
0:56 - 0:57who gets the check --
-
0:57 - 1:01is not the same
as the economic incidence. -
1:01 - 1:03That should always
already be familiar -
1:03 - 1:05from our discussion of taxes.
-
1:06 - 1:09Similarly, who benefits from the subsidy
-
1:09 - 1:10does depend
-
1:10 - 1:14on the relative elasticities
of demand and supply -- -
1:14 - 1:16again, just as with taxes.
-
1:16 - 1:20Finally, subsidies must
be paid for by taxpayers, -
1:20 - 1:21so instead of revenues,
-
1:21 - 1:23there's a cost to a subsidy.
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1:24 - 1:27And they create
an inefficient increase in trade, -
1:27 - 1:30also called a deadweight loss.
-
1:30 - 1:31Let's take a look in more detail.
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1:31 - 1:34Okay, we have a lot to cover
in this diagram -
1:34 - 1:35so put on your thinking hats.
-
1:35 - 1:38We begin as usual at the Market --
free market equilibrium. -
1:38 - 1:42Let's say that's at price
of two dollars and this quantity. -
1:42 - 1:45Now, I'm not going
to go through the proof -
1:45 - 1:49that the legal incidence
of who gets the subsidy -
1:49 - 1:51does not influence
the economic incidence. -
1:52 - 1:55Instead, I'm going
to jump right to the key point, -
1:55 - 1:57which is that a subsidy drives a wedge
-
1:57 - 2:02between the price received by sellers
and the price paid by the buyers. -
2:02 - 2:04The only difference from the tax
-
2:04 - 2:07is that the price received
by sellers with the subsidy -
2:07 - 2:10is going to be more
than the price paid by the buyers. -
2:12 - 2:15So we can use the same
wedge analysis that we used before -
2:15 - 2:17except we're going
to drive the wedge -
2:17 - 2:19into the diagram
from the right hand side. -
2:20 - 2:22So now consider
the height of this wedge -- -
2:22 - 2:23let's suppose that's a dollar --
-
2:23 - 2:28and let's drive it in to the diagram
until the top hits the supply curve -
2:28 - 2:30and the bottom
hits the demand curve. -
2:30 - 2:32This is now going to tell us
everything we need to know. -
2:32 - 2:34So at the top, at point B,
-
2:34 - 2:37this tells us the price
received by sellers -- -
2:37 - 2:39suppose that's $2.40.
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2:39 - 2:42The bottom, at point D,
-
2:42 - 2:45tells us the price
paid by the buyers -- $1.40. -
2:45 - 2:48Notice that the price
received by the sellers -
2:48 - 2:50has got to be $1 more
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2:50 - 2:52than the price paid by the buyers,
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2:52 - 2:55the $1 coming from the subsidy.
-
2:56 - 2:58Notice also the key idea --
-
2:58 - 3:02it doesn't matter
whether the suppliers -
3:02 - 3:04receive the check
from the government, -
3:04 - 3:08or whether the buyers receive
the check from the government. -
3:08 - 3:11On net, when all is said and done,
-
3:11 - 3:15the sellers will receive
$2.40 per unit, -
3:15 - 3:18and the buyers
will pay $1.40 per unit. -
3:18 - 3:21By comparing
with the free market price, -
3:21 - 3:25we can see who is getting
the relative gain from the subsidy. -
3:25 - 3:26In this case,
-
3:26 - 3:30both the suppliers and demanders
get some of the gain. -
3:30 - 3:33So the suppliers
used to get $2 per unit -- -
3:33 - 3:37now they're getting $2.40,
so they get 40% of the gain. -
3:38 - 3:40The buyers used to pay $2 --
-
3:40 - 3:45now they're paying $1.40,
so they get 60% of the gain. -
3:45 - 3:47Who gets the gain
-
3:47 - 3:48is going to depend upon
-
3:48 - 3:51the relative elasticities
of supply and demand -
3:51 - 3:53and you want
to convince yourself of that -
3:53 - 3:55by drawing some more
diagrams like this, -
3:55 - 3:58but draw them with
a really inelastic supply curve. -
3:58 - 3:59See what happens.
-
3:59 - 4:02Then draw it with a more
elastic supply curve, -
4:02 - 4:05a supply curve which is more
elastic than the demand curve. -
4:05 - 4:08See what happens --
so test out different things. -
4:08 - 4:13Next, a tax creates
revenues for the government -- -
4:13 - 4:16a subsidy creates
costs to the government. -
4:16 - 4:17What is the cost?
-
4:17 - 4:22Well, notice that
the per unit subsidy is $1 -- -
4:22 - 4:25that's given
by the height of the wedge. -
4:25 - 4:27What's the quantity
which is subsidized? -
4:27 - 4:29Well, it's this quantity right here.
-
4:29 - 4:32So the total cost
of the subsidy -
4:32 - 4:35is $1 times the quantity,
-
4:35 - 4:38or the subsidy amount
times the quantity, -
4:38 - 4:42so it's given by
this blue area right here. -
4:43 - 4:45Finally -- got a lot to cover,
-
4:45 - 4:48but it should all be
fairly standard now -- -
4:48 - 4:51notice that what the subsidy does,
another effect of the subsidy, -
4:51 - 4:53not surprisingly,
-
4:53 - 4:55is that it increases
the quantity exchanged. -
4:55 - 4:58So it increases it from quantity --
no subsidy -- -
4:58 - 5:00to the quantity with the subsidy.
-
5:00 - 5:04Now, on these additional units exchanged,
-
5:04 - 5:07notice what the supply
and demand curve tells us. -
5:07 - 5:10It tells us that
on those additional units, -
5:10 - 5:15the cost to the suppliers
of supplying those units -
5:15 - 5:19exceeds the value
to the demanders of those units. -
5:19 - 5:24So, this additional quantity
is creating a waste. -
5:25 - 5:28The cost to the suppliers
exceeds the value -
5:28 - 5:31of those units to the demanders.
-
5:31 - 5:34So the subsidy
creates a deadweight loss. -
5:34 - 5:37There's too much trade going on,
-
5:37 - 5:38as opposed to the tax --
-
5:38 - 5:41where the tax
reduces beneficial trades, -
5:41 - 5:46the subsidy increases
wasteful trades. -
5:46 - 5:49Okay, take a good look at
this diagram. -
5:49 - 5:52Make sure you understand
each part of the diagram, -
5:52 - 5:55and we're going to give
some applications -
5:55 - 5:57and give a few more ways
of looking at this diagram. -
5:57 - 5:59But this is really the key idea --
-
5:59 - 6:01everything in this diagram
right here. -
6:02 - 6:05Do you remember our intuition
for who bears the burden of a tax? -
6:05 - 6:08It's that elasticity is like escape.
-
6:08 - 6:11So the more elastic
the demand curve, -
6:11 - 6:14the more the demanders
are able to escape the tax. -
6:14 - 6:18The more elastic the supply curve
relative to the demand curve, -
6:18 - 6:21the more able the suppliers
are to escape the tax. -
6:21 - 6:24Here I want to give you
a similar intuition -
6:24 - 6:28and way of reminding yourself
about what happens with the subsidy. -
6:28 - 6:31And that is,
when you have no elasticity -
6:31 - 6:35or when you have
an inelastic curve, -
6:35 - 6:36then there's no entry.
-
6:36 - 6:39No elasticity equals no entry.
-
6:39 - 6:41And when there's no entry,
-
6:41 - 6:44that's when you gain
the benefits of the subsidy. -
6:44 - 6:48When no one can
come in to take the subsidy, -
6:48 - 6:50you get the benefit.
-
6:50 - 6:53So when there's no elasticity,
no entry, -
6:53 - 6:55you get the benefit of the subsidy.
-
6:55 - 6:56Let's take a look.
-
6:56 - 6:58Let's redo our tax analysis.
-
6:58 - 7:01So suppose we have
a fairly elastic demand curve -
7:01 - 7:04and a fairly inelastic supply curve,
-
7:04 - 7:06and here's our tax wedge.
-
7:06 - 7:08We drive it in the diagram
and what we see -
7:08 - 7:13is that the suppliers bear
more of the burden of the tax. -
7:13 - 7:15That is, the price to them falls.
-
7:15 - 7:17They're bearing
the brunt of the tax -
7:17 - 7:21because the suppliers
have nowhere else to go. -
7:21 - 7:24They can't take their resources
used to produce this good -
7:24 - 7:27and use it to produce
other goods in the economy. -
7:27 - 7:30The supply is relatively fixed,
-
7:30 - 7:34the resources are most useful
for producing this particular good, -
7:34 - 7:36so the suppliers cannot escape.
-
7:37 - 7:39For the very same reasons,
-
7:39 - 7:42the suppliers will get most
of the gains of a subsidy. -
7:42 - 7:44So here's our subsidy wedge --
-
7:44 - 7:46we drive it in to the diagram.
-
7:46 - 7:50We could read off the diagram here
that the price to the suppliers -
7:50 - 7:56is going to rise much more
than the price to the buyer falls, -
7:56 - 7:58relative to the market price.
-
7:58 - 7:59So what's going on?
-
7:59 - 8:03Well, what's going on
is that we have this subsidy, -
8:03 - 8:06but because
the supply curve is inelastic, -
8:06 - 8:08we don't see a lot of resources
-
8:08 - 8:11coming from elsewhere
in the economy -
8:11 - 8:15to grab up that subsidy,
to take that subsidy. -
8:15 - 8:18The resources
in the rest of the economy -
8:18 - 8:21are not good
at producing this type of good, -
8:21 - 8:25so it's only the resources
which are already in this market, -
8:25 - 8:27the fixed resources --
-
8:27 - 8:30they're the ones which
are going to grab up the subsidy. -
8:30 - 8:31The price is going to go up
-
8:31 - 8:34because we don't
have a lot of resources -
8:34 - 8:37coming from other areas
of the economy to produce this good. -
8:38 - 8:41Or we can think about this
from the point of view -
8:41 - 8:42of the demanders.
-
8:42 - 8:45When the demand
is relatively elastic, -
8:45 - 8:47they can escape the tax.
-
8:47 - 8:51But, similarly,
when the demand is elastic, -
8:51 - 8:53the demanders from other parts
of the economy -
8:53 - 8:55with the substitute goods,
-
8:55 - 8:57they're going to come in
and grab up that subsidy. -
8:57 - 8:59They're going to keep the price high
-
8:59 - 9:04because demanders are going to
stop consuming the substitute good, -
9:04 - 9:06and they're instead
going to move into this market -
9:06 - 9:08to consume this good.
-
9:08 - 9:12And because you get
all of these demanders -
9:12 - 9:15from elsewhere in the economy
coming in to buy this good, -
9:15 - 9:17the price doesn't fall very much.
-
9:17 - 9:21Okay, once again,
play around with this. -
9:22 - 9:24Draw some demand and supply curves,
-
9:24 - 9:26put in a tax wedge,
put in a subsidy wedge -
9:26 - 9:29until this all becomes intuitive.
-
9:29 - 9:31And remember that,
in the case of subsidies, -
9:31 - 9:35no elastic or less elastic
means less entry, -
9:35 - 9:40less entry means
more gains to the subsidy -- -
9:40 - 9:42they get more
of the benefits of the subsidy. -
9:42 - 9:44Let's do an application.
-
9:44 - 9:46Farmers in
California’s Central Valley -
9:46 - 9:48get a big water subsidy.
-
9:48 - 9:52They typically pay $20
to $30 an acre-foot for water -
9:52 - 9:56that costs $200 to $500
an acre-foot to produce. -
9:56 - 9:58So who benefits
the most from this subsidy? -
9:58 - 10:01Is it the California
cotton suppliers, -
10:01 - 10:04or is it the buyers
of California cotton? -
10:04 - 10:06Let's think about it this way.
-
10:06 - 10:08The buyers of California cotton --
-
10:08 - 10:10what kind of substitutes
do they have? -
10:11 - 10:13Are they going to have
an elastic demand -
10:13 - 10:15or an inelastic demand?
-
10:16 - 10:18The buyers of California cotton
-
10:18 - 10:20are going to have
a very elastic demand, right? -
10:20 - 10:24Because they can substitute
cotton grown in Georgia, -
10:24 - 10:27they can substitute
cotton grown in Pakistan, -
10:27 - 10:30in India, in many
other places in the world. -
10:30 - 10:33In fact, the price of cotton
is basically set in a world market, -
10:33 - 10:38so if we have a subsidy
for California-cotton suppliers, -
10:38 - 10:41that's not going to push the world
price down very much at all. -
10:41 - 10:44It's simply going
to induce some buyers -
10:44 - 10:46to buy more California cotton
-
10:46 - 10:51and a little bit less of cotton
from Pakistan or from India. -
10:51 - 10:54On the other hand,
the California cotton suppliers -- -
10:54 - 10:57they've got a pretty
inelastic supply curve. -
10:57 - 10:59There's not that much
land there to begin with, -
10:59 - 11:03and it's really pretty fixed
for growing agricultural goods, -
11:03 - 11:06and probably fairly fixed
for growing cotton. -
11:06 - 11:09So, the California cotton suppliers
-
11:09 - 11:12are going to get
most of the benefits -
11:12 - 11:13of this subsidy.
-
11:13 - 11:17It's not going to lower
the price of pants at the Gap. -
11:17 - 11:20Instead it's going
to go into the pockets -
11:20 - 11:23of the California cotton suppliers,
of the farmers. -
11:23 - 11:26Not surprisingly,
it's the farmers in California -
11:26 - 11:30who lobby extensively
for this subsidy, -
11:30 - 11:32and it's not
the consumers of cotton. -
11:32 - 11:34So as we've just shown,
-
11:34 - 11:36subsidies can often be wasteful.
-
11:36 - 11:39And one of the reasons that
we have subsidies is politics -- -
11:39 - 11:41the power of Special
Interest Groups in lobbying -
11:41 - 11:42and so forth.
-
11:42 - 11:44We'll talk more
about that another time. -
11:44 - 11:47However,
subsidies can also be useful, -
11:47 - 11:52particularly if there's a reason
why the demand for a good -
11:52 - 11:55understates
the true value of that good. -
11:56 - 11:58We'll give lots of examples
of this type of thing -
11:58 - 12:01when we come
to talk about externalities, -
12:01 - 12:04but before we do that I want
to give you one more example, -
12:04 - 12:06where this should be
fairly intuitive -
12:06 - 12:08and that's wage subsidies.
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12:08 - 12:09So the next lecture,
-
12:09 - 12:11we'll look at wage subsidies
-
12:11 - 12:14for unskilled
or lower-skilled workers -
12:14 - 12:16and we'll compare that
with the minimum wage. -
12:16 - 12:17Thanks.
-
12:19 - 12:20- [Narrator]
If you want to test yourself, -
12:20 - 12:22click “Practice Questions.”
-
12:23 - 12:26Or, if you're ready to move on,
just click “Next Video.” -
12:26 - 12:29♪ [music] ♪
- Title:
- Subsidies
- Description:
-
What is a subsidy? A subsidy is really just a negative or reverse tax. Instead of collecting money in the form of a tax, the government gives money to consumer or producers. In this video, we look at the subsidy wedge and who benefits the most from different subsidies.
Microeconomics Course: http://mruniversity.com/courses/principles-economics-microeconomics
Ask a question about the video: http://mruniversity.com/courses/principles-economics-microeconomics/subsidies-definition-subsidy-wedge#QandA
Next video: http://mruniversity.com/courses/principles-economics-microeconomics/wage-subsidies-minimum-wage-earned-income-tax-credit
- Video Language:
- English
- Team:
- Marginal Revolution University
- Project:
- Micro
- Duration:
- 12:32
Marilia_PM edited English subtitles for Subsidies | ||
Cindy Hurlow edited English subtitles for Subsidies | ||
Cindy Hurlow edited English subtitles for Subsidies | ||
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MRU2 edited English subtitles for Subsidies | ||
MRU2 edited English subtitles for Subsidies | ||
MRU2 edited English subtitles for Subsidies |