Export Subsidies (HL IB Economics)
Revision Note
Author
Steve VorsterExpertise
Economics & Business Subject Lead
An Explanation of Export Subsidies
Both subsidies and export subsidies lower the cost of production for domestic firms
They can increase output and lower prices
With lower prices their goods/services are more competitive internationally
If firms are able to meet all of the domestic demand (Dd) then the excess supply may be exported
Otherwise, the level of imports will decrease
The increased output may result in increased domestic employment
Following the 2nd World War, the European Union subsidised food production and this has continued ever since
Once food security had been established within Europe, countries were able to start exporting the excess supply that subsidies generate
European Union subsidies for truffle producers shift the domestic supply curve to the right which decreases the level of truffle imports required from Q1Q3to Q2Q3
Diagram Analysis
The domestic market for truffles in the EU was initially in equilibrium at PwQ3
Domestic firms supplied up to Q1, while Q2-Q1 was imported into the EU
The implementation of the subsidy lowered firms costs of production, shifting the domestic supply curve from Sd to Sd + subsidy
Domestic firms increase output and market share from Q1→Q2
Imports reduce from Q1Q3 → Q2Q3
An Evaluation of Subsidies
An evaluation of the effectiveness of the use of subsidies as a form of protectionism is best done by considering the impact on all of the relevant stakeholders
The effect on different stakeholders can be considered by analysing each area of the international subsidy diagram
The stakeholders affected are domestic and foreign producers, consumers, government, and society (welfare)
An Evaluation of the use of Subsidies to Protect Domestic Firms
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Domestic Producers |
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Foreign Producers |
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Consumers |
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Government |
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Society (Welfare) |
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Worked Example
The diagram below illustrates the EU truffle market. Due to domestic pressures, the EU implemented a subsidy to truffle farmers. SD is EU domestic supply, DD is EU domestic demand, Sw is world supply and Ssubsidy is domestic supply with the tariff.
Answer:
Using information from the diagram
a) Calculate the cost of the subsidy to the government [2]
Step 1 - Identify the size of the subsidy and the quantity domestic producers supply with the subsidy
Size of subsidy = €10 per unit
Domestic producer supply = 15m Kg's
Step 2 - Calculate the subsidy spend by government
Total subsidy = €10 x 15m Kg's
Total subsidy = €150m
[1 mark for any correct working and 1 mark for correct answer]
b) Calculate the change to the quantity of imports [2]
Step 1 - Identify & calculate the original level of imports
= (30m kg's - 5m kg's)
= 25m kg's
Step 2 - Identify & calculate the new level of imports
= (30m kg's - 15m kg's)
= 15m kg's
Step 3 - Calculate the difference
= (25m kg's - 15m kg's)
= 10m kg's
The level of truffle imports has fallen by 10m kg's
[1 mark for any correct working and 1 mark for correct answer]
c) Calculate the change to domestic producer revenue as a result of the subsidy [2]
Step 1 - Identify & calculate the original level of domestic producer revenue
= €10 x 5m kg's
= €50m
Step 2 - Identify & calculate the new level of domestic producer revenue
= €20 x 15m kg's
= €300m
Step 3 - Calculate the difference
= €300m - €50m
= €250m
Domestic producer revenue has increased by €250m
[1 mark for any correct working and 1 mark for correct answer]
Exam Tip
When evaluating the use of subsidies in essay responses, it is worthwhile considering both the length of time that the subsidy has been in place, along with the size of the subsidy.
If the subsidy is large and has been in place for a long time, the industry is likely to be a global monopoly such as the USA cotton industry. Their price is effectively the world price.
This is one reason why the WTO aims to limit export subsidies. They put small-scale farmers in developing nations out of business, often decimating the industry and thus increasing unemployment. Compared to fifty years ago, very few African countries now produce cotton. This is entirely down to the size and longevity of the subsidies in the USA.
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