5. Corrective Subsidy

Based on Dr. Said's Figure 9 + Handwritten Notes pp. 5-7

How It Works

Government subsidizes each unit by MEB to encourage more production/consumption to the efficient level.

Corrective Subsidy = MEB per unit

Why does the subsidy work? Consumers only see MPB (their private benefit). With a subsidy of MEB per unit, the effective demand shifts up from MPB to MPB + MEB = MSB. Now the market naturally reaches the point where MSB = MSC - the efficient point!

Interactive Chart (Figure 9)

Efficiency Gain Triangle Gov't Cost Rectangle

Subsidy per unit: $10

Surplus Decomposition (Vaccination Example from Notes)

Using the vaccination table (Q* market = 3, Q efficient = 4, Subsidy = MEB = $20):

Producer:+35 Produce more (4 vs 3) & receive higher price (90 vs 80)

Consumer:+35 Consume more (4 vs 3) & pay less (90-20=70 vs 80)

3rd Party:+20 External benefit from extra vaccination

Government:-80 Subsidy cost = 4 units x $20 = $80

Net Society:+10 Efficiency GAIN = +35+35+20-80 = +10

Geometric Companion: Areas on the Graph

Step-by-Step Surplus Calculation

Producer Surplus Change: +35

Producer now produces Q=4 at market price $90 (up from Q=3 at $80).

Gain = rectangle(3 x 10) + triangle(1/2 x 10 x 1) = 30 + 5 = 35

Consumer Surplus Change: +35

Consumer now consumes Q=4 and pays only $70 (market price $90 minus subsidy $20), down from $80.

Gain = rectangle(3 x 10) + triangle(1/2 x 10 x 1) = 30 + 5 = 35

3rd Party Gain: +20

Additional external benefit from unit 4: two triangles = 1/2 x 20 x 1 + 1/2 x 20 x 1 = 10 + 10 = 20

Government Cost: -80

Subsidy per unit ($20) x efficient quantity (4) = $80

Graphical Check: Triangle = +10

$Efficiency\ Gain = \frac{1}{2} \times 20 \times 1 = 10$

The triangle E1-E*-L = the net efficiency gain from moving to the efficient point.

Economics Help: Subsidies for Positive Externalities tutor2u: Government Subsidies