Export Subsidy – Price Effects and Welfare LossSL
Global EconomicsThis diagram shows how an export subsidy raises the domestic price above the world price, encouraging producers to export more while reducing consumer welfare and creating deadweight losses.
Curves and elements
- dd
- Dd: Domestic demand curve for the good.
- sd
- Sd: Domestic supply curve without subsidy.
- pw
- Pw: Free-trade world price.
- pw s
- Pw+s: Domestic price after subsidy (world price plus subsidy).
- q1
- Q1: Domestic quantity demanded after subsidy.
- q2
- Q2: Domestic quantity supplied before subsidy.
- q3
- Q3: Domestic quantity supplied that would equalize exports without subsidy (shown for reference).
- q4
- Q4: Domestic quantity supplied after subsidy.
- exports no subsidy
- Exports without subsidy: Q3 − Q2 at Pw.
- exports with subsidy
- Exports with subsidy: Q4 − Q1 at Pw+s.
- welfare loss
- Welfare Loss: Two grey triangles representing deadweight losses from over-production and under-consumption.
Key explanations
- 1
Under free trade at the world price (Pw), domestic producers supply Q2 and domestic consumers demand Q4, with exports equal to Q4 − Q2.
- 2
An export subsidy allows firms to sell abroad at Pw while receiving the subsidy, so they raise domestic prices to Pw+s (world price plus subsidy).
- 3
At the higher price Pw+s, domestic production expands from Q2 to Q4, while domestic consumption falls from Q4 to Q1, increasing exports to Q4 − Q1.
- 4
Government budget pays the subsidy per unit exported, generating two welfare-loss (deadweight) triangles: one next to producers (over-production) and one next to consumers (under-consumption).
- 5
Although producers gain from higher prices and greater output, taxpayers finance the subsidy and consumers face higher prices, leading to a net welfare loss.
Example exam question
Using a supply and demand diagram, explain the effects of an export subsidy on domestic prices, quantities, and welfare.
Show example answer
An export subsidy raises the domestic price from Pw to Pw+s, shifting domestic consumption down to Q1 and production up to Q4. Exports rise from (Q4 − Q2) to (Q4 − Q1). Consumers lose surplus due to higher prices and lower consumption, while producers gain. Government outlays equal the subsidy per unit times exports. The grey triangles show welfare loss from inefficient over-production and under-consumption.
