The impact of subsidy
The supply and demand framework can also be used to analyze the impact of a government subsidy. A subsidy is a payment to either the buyer or seller of a good or service, usually on a per-unit basis. Subsidies are often granted in an effort to help buyers afford a good or service, or to increase the profitability of producers in an industry. As we have seen in other cases, however, the effect of a government program often differs substantially from its original intent. Because prices change when subsidies are imposed (just as when taxes are imposed), the benefit of a subsidy can be partially, or totally, shifted from
buyer to seller, or vice versa. Suppose that the government, in an effort to make textbooks more affordable, gives college students (buyers) a $20 subsidy for each book they buy. The $20-per-book subsidy paid to the buyers will increase demand by the amount of the subsidy (shift from D , to D2).As the result of the subsidy, the equilibrium price will increase from $80 to $90, and the total quantity purchased will expand to 110million textbooks per year.
The subsidy program reduces the students’ out-of-pocket cost of a textbook (from $80 to $70), but the net gain to them is less than the amount of the subsidy. Why? Even though the textbook subsidy is granted to buyers, substantial benefits also accrue to sellers. Because the subsidy program increases the demand for textbooks, pushing their price upward by $10, half of the benefits are captured by sellers (including resource suppliers like copy editors, authors, and paper suppliers).
Alternatively, if textbook supplier? had been granted a $20 payment from the government for each textbook sold, the supply curve would have shifted downward by the amount of the subsidy. This would cause the market price of textbooks to decline to $70. In this case, buyers pay $10 less than before the subsidy program, while the sellers receive $10 more (the sellers now get $90 for each book sold the $70 market price plus the $20 government subsidy). Just like a tax, a subsidy results in the same outcome, regardless of whether the subsidy is granted to buyers or sellers.