subsidy and market failure

Question 1

what is a subsidy and what market failure does it resolve

Answer 1

-a money grant given to firms by the government to decrease their cost of production and encourage a rise in output
-positive and consumption externality

Question 2

general effect of subsidy on positive externality

Answer 2

-decreases a firms cost of production
-decrease price, increase quantity
-resolves issues of underconsumption/production
-leads to allocative efficiency and general welfare gain

Question 3

effect of subsidy on positive externality and consumption curve

Answer 3

consumption
-at q star, new price level

production
-at q star (MSc = MPC + tax)

Question 4

issues of subsidy when resolving market failure

Answer 4

-cost (go to new equilibrium and up)
-difficult to set at the right level
-price inelastic demand
-will the firms use the subsidy correctly