D oes a subsidy create a deadweight loss? Why or why not? A) Yes. While producer

Question

Does a subsidy create a deadweight loss? Why or why not?

A) Yes. While producers and consumers gain surplus, the cost of the subsidy exceeds their gain. The cost of the subsidy is the subsidized equilibrium quantity, which is lower than the free-market quantity, multiplied by the subsidy per unit.

B) Yes. While producers and consumers gain surplus, the cost of the subsidy exceeds their gain. The cost of the subsidy is the subsidized equilibrium quantity, which is higher than the free-market quantity, multiplied by the subsidy per unit.

C) No. consumers and producers gain surplus, while the cost of the subsidy is minimal. In fact, a subsidy often results in a net gain in welfare.

D) No . Although the cost of a subsidy is typically large, there is no deadweight loss because it only occurs in the case of underproduction. A subsidy increases the equilibrium quantity relative to the free-market quantity.

Explanation / Answer

B) Yes. While producers and consumers gain surplus, the cost of the subsidy exceeds their gain. The cost of the subsidy is the subsidized equilibrium quantity, which is higher than the free-market quantity, multiplied by the subsidy per unit.

When a product is subsidised, its quantity will be higher than what it would have sold without the subsidy.
Thus, cost of subsidy = Subsidy * subsidized equilibrium
and Deadweight Loss = (1/2)(amount of subsidy)*Change in Output

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