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Excise Subsidy
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Form of subsidy in which the government pays part of the per-unit price of a good and allows consumers to purchase as many units as desired at the subsidized price
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Examples of Subsidies
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Ex. Government may pay half a conumer's housing costs, effectively lowers the per-unit price of housing services by 50%; businesses are the largest underwriter of health care costs in the US over the past decade--> cost of providing health care to employees has been tax exempt
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Excise subsidy applied to health care purchases of particular consumer
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Consumer has weekly income of $100, mearket price of health care is $5 per unit, consumer would purchase 9 units without any subsidy ($45 and $55 of other goods)
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In order to subsidize individuals health care consumption, government pays $2 off $5 per unit cost of health care
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Subsidy lowers the effective price of health care from $5 to $3, all price reductions cause budget line to rotate --> health is now less costly and more will be consumed
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Excise subsidy lowers...
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The price of good to the consumer & so consumption of the good will increase
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Instead of an excise subsidy the government gives consumer the same assistance ($30 per week) in form of a cash grant
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Cash grant can be spent in any way recippient wants
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Lump sum transfer-
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Form of subsidy in which government gives consumer a cash grant to be spent any way the recipient wants
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What would substituting an unrestricted cash grant of $30 for the excise subsidy do to shift consumer's buget linelu
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Lump sum grant is the same as an increase in recipients' income (Parallel outward shift in the budget line) New budget line passes through point W' (optimal market basket under excise subsidy)
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When government uses a lump-sum cash grant..
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Consumer has option to purchase the same market basket that would be chosen under an excise subsidy of the same total cost
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Effect of substituting cash transfer for excise subsidy
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Consumer purchases less health care and more of other goods under the cash transfer and is better off --> Reach a higher indifference curve
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BBoth subsidies have an income effect that tends to expand health care consumption
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Only the excise subsidy has a substitution effect (relatively lower price of health care) that further stimulates health care consumption --> faced with price of only $3 per unit, recipient purchases health care up to the point where its marginal benefit (MRS between health care and other goods) is only $3
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Consumer will be better off if given cash grant instead of excise subsidy because...
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The consumer could still afford same quantities of health care, food and housing and if they chose to purcahse something else, the presumption is that they prefer the alternative to the subsidized good they were consuming= better off according to their own preferences
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Using the Consumer Surplus Approach-
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The cost to the government exceeds the benefit to the consumer by trainfular area ECB (triangle to the right of the demand curve)
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Deadweight Loss-
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Welfare cost, a measure of aggregate loss in well-being of participants in a market resulting from output not being at the efficient level; loss in well-being that results from use of the excise subsidy
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Public schools and Voucher proposal-
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More common form of subsidy is one in which the government makes a certain quantity of a good available at no cost or perhaps below the market price
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