Trade Subsidy- Trade Protectionism

Question 1

What is a trade subsidy?

Answer 1

A subsidy is financial support given by the government to domestic producers.

This reduces their costs of production.

Lower costs enable domestic producers to lower prices and better compete against international suppliers.

Question 2

Effects on the Market (using supply-demand graph terms):

Answer 2

Original supply curve: SD

Supply curve with subsidy: SD_sub (shifts right/down) — domestic supply increases because producers can supply more at each price level.

World price: PW

Subsidised price: Psub (lower than PW or domestically competitive)

Quantity changes:

Domestic supply increases (moves from Q0 to Q2)

Imports fall (reduced from Q3 to Q1)

Domestic demand remains (or may change slightly depending on price effect)

Question 3

Benefits of Trade Subsidy:

Answer 3

Protects Domestic Industry

By lowering costs, domestic producers can compete better with foreign firms.

May help infant or struggling industries grow.

Increase Domestic Supply

Domestic firms produce more, possibly achieving economies of scale.

Reduces Dumping

Dumping (selling below cost) becomes less attractive as domestic firms are subsidized.

Domestic Employment

Could maintain or increase jobs if domestic producers grow output.

Improves Current Account Position

Because domestic production increases and imports fall, money spent abroad decreases.

This could improve the trade balance.

Question 4

Downsides:

Answer 4

Deadweight Loss (DWL):

Subsidies distort market prices, leading to inefficiencies (represented by areas like DWL on graphs).

Subsidies are funded by taxpayers, which has an opportunity cost.