The Effects of Subsidies on the Supply & Demand Curve
Subsidies are grants given to businesses or customers in order to boost sales. These grants are used whenever there is a shortage in supply, to encourage the purchase of safety or healthy products, or whenever it is in the best interest of the public. Understanding the effects subsidies have on supply and demand can help you determine the impact these grants can have on your business.
The Law of Supply indicates that as price increases, there is more incentive for producers to provide their goods or services. Imagine an x and y axis, where x is price and y is quantity. Given this scenario, the supply curve would be upward sloping due to the positive relationship between price and quantity. The Law of Demand reveals that consumers desire more goods or services as price declines. The demand curve is downward sloping, demonstrating an inverse relationship between price and quantity. The point where demand intersects supply is known as the equilibrium point. Quantity demanded and quantity supplied is not to be confused with the supply and demand curves. The curves plot the overall relationship between price and quantity. Quantity supplied and quantity demanded are individual points on their relevant curves.
Subsidies for producers increase supply and the quantity demanded by consumers. The government provides production subsidies whenever it is in the interest of the public in order to meet demand. As the producer increases supply, the cost of production is reduced, allowing the supplier to profit from both the subsidy and lower costs. The supply curve shifts downward and to the right due to the lower costs and higher quantity provided. Lower costs to the manufacturer are then transferred to the consumer in the form of lower prices. Cost-conscious consumers will then be more inclined to purchase the product. As a result of the subsidy, the increased supply will be able to accommodate the higher quantity demanded. Although quantity demanded increases, the demand curve does not shift. Instead, the new equilibrium point is where the shifted supply curve meets the higher quantity demanded point.
Government rebates are subsidies provided to consumers to encourage the purchase a product. Government rebates can be for a target industry like the automobile industry, or for a specified good, such as energy-efficient appliances. If a customer wanted a product but was discouraged due to higher costs, a rebate could help foster the sale. Subsidies are offered to the consumer for each product they purchase, providing further incentive. The demand curve shifts to the right because at any price, consumers are more willing to buy because of the rebate. Business owners are also rewarded by the increase in sales. The price rises as a result of the higher demand, producing even greater profits for manufacturers and business owners. The quantity supplied increases, but the supply curve is not shifted. The equilibrium point is where the shifted demand curve meets the increased quantity supplied.
In both subsidies, both suppliers and customers seem to benefit. Despite the encouragement of consumerism, this does not always benefit the economy. The money used for subsidies comes from taxpayers. If customers were going to buy the product anyway or if the majority do not want to buy the product, taxpayer funds could be wasted. Also, money cannot be printed for the purpose of introducing subsidies, as that would cause a spike in the rate of inflation. If the government is already overspending and nearing the debt limit, new subsidies could damage the nation's credit rating and increase the public's debt load.