Hello.
In this video, I'm going to show you how to
determine accurately the incidence of a subsidy.
Because it seems like some students still
have problems with interpreting what are the
effects of subsidy.
Now, before we visit the case of a subsidy,
let's look at how we determine the incidence
of tax.
So, a tax raises the production cost.
So your supply curve is going to fall, okay?
And P and Q. You can see that your original
equilibrium is here.
This is P1.
This is Q1, okay?
Followed by P2, Q2.
So the total tax is given by the vertical
distance between the supply curves.
So total tax is T multiplied by Q2.
The consumer's share is always given by the
change in price multiplied by Q2.
In other words, a consumer will only know
that he or she has been taxed after the market
price changes.
So you need to take the difference in the
price, multiplied by Q2.
So I'm going to shade the consumer share in
yellow.
It's here.
That means your producer's share is given
by 1 minus 2, which gives you this area here.
Okay?
Now, before I move on to consider the incidence
of a subsidy, I just want to make sure we
are clear on one thing here, which is, even
though in this case, the demand curve is relatively
steep, and you know that if PED is less than
1, your increase in price will lead to a less
than proportionate fall in quantity demanded.
But please do not conclude that as a result,
total revenue increases.
Because some students are inclined to see
that.
Okay, before a tax, this is the total revenue.
And after a tax, the total revenue seems to
have gone up.
This conclusion is wrong because the effective
price that producers get is not P2.
Producers effectively get P2 minus T. Because,
let's not forget, after they collect the revenue,
right, from the consumers, they have to surrender
a tax amount per unit sold to the government,
so what they get is P2 minus T. That means
with the tax, both producers and consumers
will suffer.
Okay?
Great.
So, let's say you're clear on that, let's
look at the incidence of a subsidy.
So, I have a shift in my supply curve.
This time around it's a shift to the right
because a subsidy lowers production cost,
so if I have a subsidy that shifts my supply
to the right, this is P1, Q1, and P2, Q2,
is here.
Now, there's a very large tendency for students
to look at the incidence based on this distance
here.
Now, that is not correct.
Why?
In considering that incidence of a tax or
a subsidy, you should always focus on the
new equilibrium quantity, not the old one.
The old one is what you see before the subsidy.
So if a subsidy, you should always consider
from Q2.
But students are naturally a bit hesitant
to look at incidence from here because you
are extending your line to blank space, right?
So, I'll say as a matter of habit, I will
always first indicate -- is something wrong
here.
Sorry about that.
Okay.
So I'm always going to indicate the size of
the subsidy as measured from Q2, so now I
have one line that extends all the way up.
So I'm going back to the same derivation.
The total subsidy is S multiplied by Q2.
This is equation 1.
You can see the parallel here.
And the consumer's share is the change in
price multiplied by Q2, which means this is
my consumer's share.
Okay?
Whereas the producer's incidence is, again,
1 minus 2, which leaves me with this amount.
And you can see a clear difference here, all
right?
In the case of a tax, the consumer's share
is the one that lies above, all right?
Whereas when you have a subsidy, the consumer's
share is now below.
All right?
So, to make sure you get the derivation right,
you have to practice right.
That's definite, okay?
But you can also refer to the series of steps
here in my book.
There are five steps to get the incidence
right.
So, we always shift the supply curve, unless
it's really specified otherwise.
You always look at the new equilibrium quantity.
The vertical distance between the supply curves
at Q2 is the size of the tax or the subsidy.
The consumer's share is given by the change
in price, and whoever has a steeper curve
will have a larger incidence.
But equivalently, whoever has a more gentle
curve will have a lower incidence.
Okay?
So, I hope that helps, and, as always, if
you have questions, feel free to let me know,
because I can always do a video and then upload
to provide clarification, okay?
You can contact me at thateconstutor@gmail.com
or you can visit my website at thateconstutor.com.
Yeah.
Loads of other videos up there.
Okay?
Thank.
