'Subsidies are payments made by the government to producers to increase the supply of a particular good or service to a market.'
When governments pay subsidies to suppliers their unit costs of production are decreased. It now costs less for suppliers to supply the product onto the market, the effect on our supply and demand diagrams is that supply will shift outwards.
- Subsidies reduce the cost of production for firms.
- This causes a shift from S1 to S2
- The market mechanism creates a new equilibrium at a lower price (P2) and increased quantity (Q2).
- The unit value of the subsidy is the amount of subsidy the government pays per unit is shown by the vertical distance between S1 and S2 (a to P1).