Hello everyone, I’ve got a general question about the negative effects of subsidies. In the notes and curriculum, it is said that subsidies result in inefficient allocation of resources because there will be a deadweight loss. Although, I cannot understand why it is the case. Look at the picture 1 depicting the situation without any subsidies. Blue line is a demand curve, red line is a supply curve (then there is also another purple line that represents the shift of the supply curve after the subsidy is introduced):
Here are consumer and producer’s surplus ares after the subsidy takes effect:
To me, in all the cases the sum of the consumer and producer’s surplus areas gets bigger after the subsidy is introduced. Thus I cannot understand where the deadweight Loss comes from? I would understand that the TOTAL society’s surplus gets smaller, because the government spends money on the subsidies, which don’t bring the equivalent level of surplus for both sides. But curriculum doesn’t say anything like that.
The problem here is the overproduction, this higher quantity produced is unnecessary and the goverment spent resources in vane, so there is the deadweight loss origin.
The fundamental is that the supply curve represents the marginal cost and the demand curve represents the marginal cost, and since we are in the new equilibrium (with the subsidy), the marginal cost is higher than the marginal benefit so the deadweight loss is created.
Thanks for your reply.
I am a bit confused. Did you mean that the Demand curve represents marginal benefits and supply curve represents marginal costs? But at the new equilibrium marginal costs are not higher than marginal benefits (or you maybe mean that the marginal costs are higher if we take them from the before-subsidy suppy curve?). At the equilibrium the MC = MB, in both of the cases. What am I missing?
Exactly, the marginal cost level is the original supply curve, and we have only one demand curve which is our marginal benefit. Thats why we get that triangle of deadweight loss, the mg cost is higher than mg benefit, and the quantity supplied which is distorted makes you produce at a non-optimal level unless companies rise their capex for production, but that never happens because subsidies just is seen as volatile and non consistent overtime and seen just as a help.