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Excess burden of the subsidy

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Suppose bread is subsidized in a small Caribbean nation with a high percentage of citizens who live in poverty. The subsidy is paid to suppliers of bread by the government in the amount of 50 pesos per loaf. In the absence of the subsidy, the price of bread would be 100 pesos per loaf. Assuming that the supply of bread is perfectly elastic at the 100 peso price, what is the effect of the subsidy on the market equilibrium price of bread? Draw a graph, and explain the excess burden of the subsidy. Assuming no externalities, why will subsidy result in more than the efficient amount of bread being produced? Create a graph on a spreadsheet program

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The response provides you a structured explanation of excess burden of the subsidy. It also gives you the relevant references.

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There is no effect of the subsidy on market equilibrium price of bread. The supply is perfectly elastic at 100 pesos and the price of bread will remain 100 pesos. The effect of the subsidy is that the demand curve has shifted to the right. ...

Solution provided by:
Hatim Baxamusa, MBA
Education
  • BSc , University of Calcutta
  • MBA, Eastern Institute for Integrated Learning in Management
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