one electric car, two electric cars, three electric cars...

What is the purpose of a subsidy? Using a diagram explain how it will work and what the impact should be. 

Subsidy is the amount of money paid by the government to a producer, in order to decrease the sum that the consumers has to pay. In other words, subsidies represent payments by the government to suppliers that have the effect of reducing their costs and, consequently, encouraging them to increase output. The impact of a subsidy is the increase of supply and therefore a decrease in the market equilibrium price. 

 

In the diagram above we can see the supply (S1, S2) and demand (D) 

curves. The initial meeting point of supply and demand curves is P1Q1 with consumer surplus above the P1 level. The subsidy shifts the supply curve to the right and the equilibrium price decreases to P2. We can see a growth of consumer surplus. 

The purpose of a subsidy on electric cars, for example, is, therefore, reducing market failure (negative externalities – environmental damage) by encouraging people to buy more environmental-friendly cars. 

Why is pollution an example of a market failure? Illustrate this on a diagram. 
Pollution is an example of market failure because it is a negative externality, which leads to market imperfections. Negative externalities occur when an economic activity affects third parties (not consumers or producers). In the diagram we can see the situation when the marginal private cost = marginal social cost and the private optimum is higher than the social optimum. 

Why could electric cars also be an example of a market failure? 

1. Negative externalities (electricity is still produced mainly from fossil fuels) 

2. Positive externalities to third parties (less pollution) 

3. Imperfect competition (e.g. firms producing electric cars can create an oligopoly – nine cars will be given subsidies and, therefore, barriers of entry occur) 

How will the subsidy aim to encourage more firms to produce electric cars and also more consumers to buy them? 

Under the £43m initiative that started on 1 January 2011, buyers could get a 25% discount up to the maximum £5,000. The subsidy encourages people to buy electric cars because their prices are becoming comparable to conventional car prices. Additionally, lower maintenance costs also encourage consumers to buy environmental-friendly cars. As the former Transport Secretary, Phillip Hammond said: "The point of supporting this technology is to get it up to scale." This mean that electric cars would become more competitive with traditional cars which would encourage producers. 

Is there an argument for increased investment in technology to produce electric cars more cheaply and more effectively? The main economic goal of every company is to maximise its profits. By producing electric cars more cheaply and more effectively consumers would be encouraged to buy these products and therefore demand for these goods would rise. Moreover, investments in technology would again lead to higher competition with traditional cars causing the demand for electric cars to increase. However, people argue that electric cars are not the best way of saving our environment because they require electricity, produced mainly from coal and therefore,  there is an argument for investing in hybrid cars technology improvement instead.

Why is there such a high demand for car usage?

Cars allow people to move from place to place more or less freely. Their main advantages are on-demand and door-to-door travel. Cars are the most popular way of transport even if prices and costs of using them are higher than, for example, public transport (or a bicycle!) costs. Of course, demand depends mainly on changes in oil prices but it in a long-term demand is price inelastic. Another reason for a high demand for car usage is, arguably, the lack of close substitutes which would be able to compete with traditional cars. For example, there are more and more electric cars but the infrastructure is not adapted to them (e.g. lack of charging stations). 

Everywhere is walking distance if you have the time. ~Steven Wright

That’s what I think,

MANU