Trade Subsidy- Detailed Analysis

Question 1

Graph overview:

Answer 1

Price: Remains unchanged (at world price PW)

Domestic Demand: Remains the same at quantity Q2 (no change in demand curve)

Domestic Supply: Increases from Q0 to Q3 because the subsidy lowers production costs, shifting the domestic supply curve to the right (from SD to SD_sub)

Imports: Decrease from Q3 to Q1 (imports = difference between domestic demand and domestic supply)

Question 2

Revenue changes:

Answer 2

Domestic Producer Revenue:

Increases from area a to b + c (area under price and quantity for domestic supply)

Foreign Producer Revenue:

Decreases from b + c to c because imports fall

Government Cost:

The government pays subsidy amount over quantity produced domestically (area a + b + c + d), which is the subsidy rate multiplied by the quantity supplied domestically

Question 3

Deadweight Loss (DWL):

Answer 3

Represented by areas d + e (on typical subsidy graph)

This is the efficiency loss from the subsidy — resources are not allocated optimally, and the subsidy distorts market outcomes.

Question 4

Summary:

Answer 4

Aspect Effect
Price No change (fixed at world price)
Domestic Supply Increases (Q0 → Q3)
Domestic Demand Unchanged (Q2)
Imports Decrease (Q3 → Q1)
Domestic Producer Rev Increase (gain revenue with subsidy)
Foreign Producer Rev Decrease (less imported goods sold)
Government Cost High (pays subsidy to domestic producers)
Deadweight Loss Exists (efficiency loss)