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Tax & Supply

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Subsidies are given to businesses when the government wants to encourage that particular activity i.e. when the government wants more of a product to be consumed. Education is one example - in various different ways (often complex and always changing!), education providers can gain subsidies for particular courses. These subsidies constantly change as the government (national or european) changes its views on which products are beneficial for society.

When a subsidy is given to a business, the cost of making each product is reduced: it still costs the same amount, but the business now has to pay less of this cost. This reduction in cost increases the profit margin and so the business receiving the subsidy will want to produce more of the product. You can often see this within farming. Each year the amount of subsidies given to particular crops or livestock will change and farmers react to this by altering the crops they plant or livestock they raise.

What does a subsidy do to the supply curve in a supply and demand diagram? It shifts the supply curve to the right because at every price each business in the market will want to produce more of the product:

The effect of a subsidy is to increase the quantity consumed and reduce the market price. Click on the diagram above to look at a business problem. Make sure you’ve looked at the indirect taxation page before you do this.