• A subsidy is opposite to a tax. It is money given by the government to encourage the consumption and production of certain goods.
  • This works something like this : (i) Producers are given money to help them cover costs -> (ii) Costs decrease for producers -> (iii) This increases supply of the good -> (iv) This will decrease the price of the good ->(v) This will increase demand/consumption of the good.
  • Subsidies can also be given to stabilise price, cut down domestic costs of production so that imports are reduced.
A subsidy diagram:

(Diagram by Komilla Chadha)
So this diagram shows a subsidy.
  1. It shows that price has decreased
  2. It shows the quantity has increased
  3. The red arrow shows the subsidy per unit
  4. To get the full subsidy given by the government we multiply subsidy per unit by quantity so the blue rectangle [p1p2(purple dot)(point vertically above purple dot)] is the total subsidy in this image.
  5. The orange square within the total cost of the subsidy is what amount of the subsidy the producer keeps.
  6. The yellow part of the subsidy is what effect the subsidy has had on consumers.
  7. The amount producers and consumers feel all depend on the elasticity of the good.
This is video by an amazing economics teacher explaining subsidies: